A spot contract is the most basic of all foreign exchange products available. It involves the purchasing or selling of currency for immediate settlement on the spot date. The trade is done at the current rate at the time you wish to make it and is often based on the urgency of your requirements. This means that you are dependent on the currency market exchange rate at that time and on the day the spot transaction needs to be made. Spot contracts can be thought of as a ‘buy now, pay now’ arrangement and are particularly useful if you need to make an immediate or urgent international payment.
As with any financial product, there are pros and cons to spot contracts and whether or not you decide to go ahead with this particular product should depend on your exact requirements. As mentioned above, if you need to make an international payment in an extremely short space of time, then spot contracts are particularly useful, as you can deliver the funds to a beneficiary in a timely fashion.
However, using spot contracts without leveraging your exposure with other financial products can be a high-risk strategy. Given how volatile the currency markets can be from one day to the next, it is important to think about the bigger picture. Let’s imagine, for example, that you decide to place an order for goods from the US that requires payment in three months’ time.
If you use a spot contract to settle that particular invoice, then you are putting yourself at the mercy of the currency gods (who do not always smile kindly). The rate at which you settle the spot contract could significantly change in the three months, meaning that the price you paid for the goods is substantially higher than it would otherwise have been. Of course, the markets might move in your favour in three months’ time but, as there is no way of knowing, it is worth considering alternative financial products if you do not need to make immediate payment.