Spot Market. Currency spot trading is the most popular foreign currency instrument around the
world, making up 37 percent of the total activity.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 a 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 an other currency. A quota
consists from two figures (for example, USD/JPY = 133.27/133.32 or, which is the same, USD/JPY
= 133.27/32). The first from 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, even in 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.
The reasons of the spot-market popularity, in addition to the fast liquidity-taking place thanks to the
volatility, belongs also the short time of a contract execution. Therefore the credit risk is on that market
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.
