The Basics of a Spot Transaction
A spot transaction refers to an exchange of currencies at the prevailing market
rate. For most currencies, a spot transaction consists of a two day settlement period
but for the Canadian dollar (CAD) and Mexican peso (MXN) a spot transaction is settled
in one business day.
That being said, if CAD or MXN is exchanged for a currency other than the USD or
each other, then the two day convention stands. The Spot Market is the trading mechanism
used to move funds on a day to day basis enabling you to buy and/or sell your domestic
or foreign currency without any rate adjustment to account for interest rate differentials.
It should be noted that some currencies can settle within spot value (same day or
next day value) but the interest rate differential is factored into the rate.
A European would like to purchase a home in the US, and will need to fund their
USD account for the transaction. They will need the funds in two days, so they book
a spot transaction today thereby locking in the rates at which the two currencies
will be exchanged. In two days time, they transfer the required EUR's to the counterparty
and receive the USD into their account.
What is Currency Hedging?