Explain the terms Spot Rate, Forward Rate and Cross Rate with reference to foreign exchange.

Spot Rate Spot Rate is a rate at which currencies are being traded for delivery on the same day. It is a price for a transaction that is happening immediately. It is the current market value of an asset available for immediate delivery at the moment of the quote. For example, an Indian Importer may need United States dollar to pay for the shipment that has just arrived. He will have to purchase the dollar ($) in the market to make payment for the import. The rate at which he will buy the dollar ($) in the market is known as the spot exchange rate. He will make the payment in terms of 'and gets in turn the United States dollar swhich will be paid to the foreign exporter. The spot exchange rate therefore, for a currency is the current rate at which one currency can be immediately converted into another currency. For example, a spot rate of $0.99/Euro indicates that one Euro can be converted into $0.99 in the market place at present. In most of the cases, the spot exchange rates are set by the demand and supply forces in the foreign exchange market. Forward Rate It is the settlement price if a transaction that will not take place until a predetermined date. Imagine a New York City firm exports its products to a German company. The business transaction will be settled in dollars so the American firm obtains revenue in its own currency and can pay its employees' salaries in dollars. If the payment by the German company is coming 6 months later, it introduces the risk that the amount of dollars they would receive for a certain amount of euros today will not be the same in 6 months' time. A company may want to limit, or hedge, this exchange rate risk by immediately converting their euro into dollars, or by purchasing forward contracts in the foreign exchange market. A forward contract is a contract to convert euros into dollars at a future date at a set price. In this way, the forward rate is a price quotation to deliver the currency in future. The exchange rate is determined at the time of concluding the contract, but payment and delivery are not required till maturity. Foreign exchange dealers and banks give the forward rate quotations for delivery in future according to the requirements of their clients. Generally, the forward quotations are given for delivery in 30 days, 90 days, and 180 days, but, the quotations may be given up to 2 years. Sometimes, forward contracts with maturities exceeding two years are also arranged by the dealers to meet specific requirements of their clients. Quotations are normally given for major currencies, but dealers also provide forward quotations for other currencies on the specific request of their clients. The forward rate for a currency may be higher or lower than the spot rate. Forward rate may be higher than the spot rate if the market participants expect the currency to appreciate vis-à-vis the other currency, say US dollar. The currency, in such case is called trading at a forward premium. If the forward rate is lower than the spot rate, the participants expect the currency to depreciate vis-à-vis the US dollar. The currency in this case, is said to be 'trading at forward discount'. Cross Rate Cross Rate is an exchange rate between two currencies computed by reference to third currency, usually the US Dollar. Cross rates are the relation of two currencies against each other based on the rate of each of them against a third currency. For example: If X, Y and Z are three different currencies and quotes are given in terms of: X/Y Z/Y Then the computation of X/Z is given by: X/Y --- Z/Y Thus attaining X/Z Thus the X/Z rate derived from the Y/X and Y/Z is called the cross rate.