Spot market

3 key takeaways

• The spot market involves the immediate exchange of assets for cash at the current market price, known as the spot price.
• Transactions in the spot market typically settle within one or two business days.
• Spot markets are essential for price discovery and providing liquidity in financial markets.

What is a spot market?

A spot market, also known as a cash market, is a financial market where financial instruments or commodities are bought and sold for immediate delivery. Transactions in the spot market are executed “on the spot,” meaning the exchange of the asset and payment occurs almost immediately. The price at which these transactions occur is referred to as the spot price.

Spot markets can exist for various assets, including currencies, commodities, and securities. These markets are characterized by their high liquidity and transparency, as prices are determined by the immediate supply and demand dynamics.

Examples of spot market transactions

• Forex spot market transaction: An investor buys 10,000 euros with US dollars at the current exchange rate of 1.20 USD/EUR. The transaction is settled within two business days, with the euros delivered to the buyer and the corresponding amount of US dollars debited from their account.

• Commodity spot market transaction: A refinery purchases 1,000 barrels of crude oil at the spot price of $70 per barrel for immediate delivery. The transaction is completed within one or two business days, with the oil delivered to the refinery and payment made to the seller.

• Securities spot market transaction: An investor buys 100 shares of a company at the current market price of $50 per share. The transaction settles within two business days, with the shares transferred to the buyer’s account and

Key features of spot markets

Spot markets have several defining characteristics:

• Immediate settlement: Transactions in spot markets settle quickly, usually within one or two business days. This contrasts with futures markets, where contracts settle at a specified future date.
• Spot price: The spot price is the current market price at which an asset is traded in the spot market. It reflects the real-time value of the asset based on prevailing market conditions.
• High liquidity: Spot markets are typically highly liquid, with a large volume of transactions occurring daily. This liquidity ensures that assets can be bought and sold quickly and at transparent prices.

Types of spot markets

Spot markets can be classified based on the type of assets traded:

• Foreign exchange (forex) spot market: This is the largest and most liquid spot market, where currencies are traded for immediate delivery. For example, exchanging US dollars for euros at the current exchange rate is a spot market transaction.
• Commodity spot market: Commodities like gold, oil, and agricultural products are traded in spot markets. For instance, buying crude oil for immediate delivery at the current market price occurs in the commodity spot market.
• Securities spot market: In stock exchanges, shares are bought and sold for immediate settlement, typically within two business days. This type of trading occurs in the securities spot market.

Importance of spot markets

Spot markets play a crucial role in the overall financial system:

• Price discovery: Spot markets facilitate price discovery by reflecting the current value of assets based on real-time supply and demand. The spot price serves as a reference for other types of financial transactions, such as futures and options contracts.
• Liquidity provision: The high liquidity in spot markets allows participants to quickly and efficiently buy or sell assets, ensuring smooth market functioning and reducing transaction costs.
• Hedging and risk management: Market participants use spot markets to hedge against price fluctuations. For example, a company might buy raw materials in the spot market to lock in current prices and protect against future price increases.
• Efficient resource allocation: Spot markets enable efficient allocation of resources by allowing market participants to respond swiftly to changes in supply and demand conditions.