Spot Market is a financial market where financial instrument are exchanged for immediate delivery, such as commodities, currencies, and securities. Delivery here means cash exchange for a financial tool. In a spot market, settlement normally happens in T+2 working days, i.e., delivery of cash and commodity must be done after two working days of the trade date. A spot market can be through an exchange or over the counter (OTC). Spot markets can operate wherever the infrastructure exists to conduct the transaction. The spot market is also known as the cash market or physical market because cash payments are processed immediately, and there is a physical exchange of assets.
Types of Spot Market
- Over the Counter- Where the Buyers and the Sellers meet to trade Bilaterally through Consensus. There is no third-Party supervisor of a transaction or a central exchange institution to regulate the trade.
- Market Exchanges– Where the Buyers and the Sellers meet to bid and offer financial instrument and commodities available. Trading can be carried out on an electronic trading platform or trading floor.
What is Spot Rate ?
Spot markets witness immediate settlement of shares, currencies, and commodities. The rate quoted for immediate settlement is known as spot rate, or spot price of an asset. It is the current market value of the asset. The spot rate is decided by the amount buyers are willing to pay for the security coupled with the amount sellers are willing to accept for the security. The spot rate is essentially decided by the demand and supply scenario. But other factors like future prospects too have an impact on the spot rate.
Characteristics of Spot Markets
Certain features are associated with spot markets. Below are the most apparent:
- Transactions are settled at the ruling price known as the spot price or spot rate.
- Delivery of the asset takes place immediately or otherwise at T+2.
- Transfer of funds is instantaneous; otherwise, settlement can be at T+2.
Advantages of Spot Market
- Trading in transparent Environment
- Trades are done and completed at the spot
- No Minimum Capital Requirement
Disadvantages
- Due to volatility true prices are not reflected on the spot
- No recourse
- Lack of Planning
- Not Flexible
- Affected by counterparty Default
Conclusion
The spot market is an important component of the global financial system. It helps in maintaining liquidity and supports price discovery. Without the spot markets, estimation of the fair value of an asset would be a tricky affair. The immediate settlement mechanism of the spot markets, helps in circulating money in the system.
