Spot Rate : The current exchange rate is usually the spot rate. It is the rate at which most foreign exchange transactions are carried out. If the contract to buy or sell foreign currency is agreed upon and executed immediately, the transaction is known as a spot transaction and the rate quoted is the spot rate. By convention, the agreed payment date or 'value date', as it is known is usually two business days after the transaction has originated. The two day period gives ample time for the two parties to send the instructions necessary to debit and credit bank accounts here and abroad.
Direct and Indirect Rates
The exchange rate may be quoted in either of the following ways:
i) US$] = Rs.35
ii) US$2.857 = Rs. 100
In the first method, the rate of exchange is expressed for a fixed unit of foreign currency. The difference in the rate is expressed by a variation in the home currency, viz the rupees. Such a method where the unit of foreign currency is kept constant and price variation is reflected in the units of home currency is known as 'direct' or 'home currency' quotation.
In the second method, the rate of exchange is expressed for a fixed unit of home currency. The difference in the rate is expressed by a variation in the foreign currency. Such a method, where the unit of home currency is kept constant and price variation is reflected in the units of foreign currency is known as 'indirect' or 'foreign currency' quotation.
In India, banks were required to quote all the rates on indirect basis till August 1, 1993. Exceptions were the sale purchase of foreign currency notes and traveller cheques where exchange rates on direct quotation were used. From August 2,1993 banks are quoting rates on direct basis only.
Buying and Selling Rates
In foreign exchange transactions, the exchange quotation will have two rates. One at which the bank is willing to buy and the other at which the bank is willing to sell. The rate at which the bank is willing to buy is known as buying rate or bid rate and the rate at which it is willing to sell is known as selling rate or offer rate. There is always some difference between buying and selling rates. This happens because foreign exchange dealer would like to make profit from the exchange transactions. Let us take an example of direct quotation.
The Authorised dealer buys at US$ I = Rs.35.3675 and sells at US $1 = Rs.35.3725. The dealer buys at lower rate and sells at a higher rate. You should note that in direct quotation, the authorised dealer buys at a lower rate and sells at a higher rate. Let us take another example, when a dealer in India buys foreign currency he pays less units of the local currency against every one unit of the foreign currency. When he sells foreign currency, he receives more units of the local currency against everyone unit of foreign currency. Let us say that the dealer quotes a spot dollar rupee rate of US$l = Rs.35.3625 - Rs.35.3675. This means that the dealer is willing to buy dollar at Rs.35.3625 per unit of dollar and sell dollar at Rs.35.3675. This also means that the dealer is willing to sell rupees at Rs.35.3625 per unit of dollar and buy rupees at Rs.35.3675 per unit of dollar. As you have noticed, there is a difference between the buying rate and the selling rate. This difference is termed as spread. Hence, spread refers to the difference between the buying rate and the selling rate in an exchange rate quotation or an interest quotation. It fluctuates according to the level of stability in the market and the volume of business.