Spot Market

Currency spot trading is the most popular foreign currency instrument around the world, making up 37 percent of the total activity The features of the fast-paced spot market are high volatility and quick profits (as well losses).

A spot deal consists of a bilateral contract whereby a party delivers a specified amount of a given currency against receipt of a specified amount of another currency from counterparty, based on an agreed exchange rate, within two business days of the deal date. The exception is the Canadian dollar, in which the spot delivery is executed next business day. The two-day spot delivery for currencies was developed long before technological breakthroughs in information processing. This time period was necessary to check out all transactions' details among counterparties. Although technologically feasible, the contemporary markets did not find it necessary to reduce the time to make payments. Human errors still occur and they need to be fixed before delivery. By the entering into a contract on the spot market a bank serving a trader tells the latter the quota – an evaluation of the currency traded against the U.S. dollar or another currency. A quota consists of two figures (for example, USD/JPY = 133.27/133.32 or USD/JPY = 133.27/32 which means the same). The first of these figures (the left part) is called the bid – price (that is a price at which the trader sells), the second (the right part) is called the ask - price (the price at which the trader buys the currency). The difference between asks and bid is called the spread. The spread, as any currency price alteration, is being measured in points (pips).

In terms of volume, currencies around the world are traded mostly against the U.S. dollar, because the U.S. dollar is the currency of reference. The other major currencies are the euro, followed by the Japanese yen, the British pound, and the Swiss franc. Other currencies with significant spot market shares are the Canadian dollar and the Australian dollar. In addition, a significant share of trading takes place in the currencies crosses, a non-dollar instrument whereby foreign currencies are quoted against other foreign currencies, such as euro against Japanese yen.

The spot market is characterized by high liquidity and high volatility. Volatility is the degree to which the price of currency tends to fluctuate within a certain period of time. For instance, in an active global trading day (24 hours), the euro/dollar exchange rate may change its value 18,000 times "flying" 100-200 pips in a matter of seconds if the market gets wind of a significant event. On the other hand, the exchange rate may remain quite static for extended periods of time, evenin excess of an hour, when one market is almost finished trading and waiting for the next market to take over. For example, there is a technical trading gap between around 4:30 PM and 6 PM EDT. In the New York market, the majority of transactions occur between 8 AM and 12 PM, when the New York and European markets overlap. The activity drops sharply in the afternoon, over 50 percent in fact, when New York loses the international trading support. Overnight trading is limited, as very few banks have overnight desks. Most of the banks send their overnight orders to branches or other banks that operate in the active time zones. Reasons for the popularity of the spot-market include the rapid liquidity, thanks to the market volatility, and short term contract execution. Therefore, the credit risk is restricted. The profit and loss can be either realized or unrealized. The realized P&L is a certain amount of money netted when a position is closed. The unrealized P&L consists of an uncertain amount of money that an outstanding position would roughly generate if it were closed at the current rate. The unrealized P&L changes continuously in tandem with the exchange rate.

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Ditulis oleh William Perkasa pada tanggal Wednesday, February 18, 2009