Question

1. What is an exchange rate, a spot rate and forward rate? What is the bid-ask spread and give an example from real data? What are the drivers of the bid-ask spread? What is a forward premium and discount and use real data to show an example of one of them and interpret the result?

Answer 1

An exchange rate is the rate between exchange of domestic currency with regards to foreign currency. It is a term which is more prevalent with foreign markets.

Spot markets are markets in which securities are traded on the spot price and the deliveries are made instantly.

forward markets are markets which are into the derivative segments and where securities are traded but delivery are made after a certain specified date.

Bid ask spread is the difference between the buying price and the selling price . buying price and selling price are quoated differently by different buyers and sellers and when an equilibrium price is reached at, transactions take place.

The drivers of bid ask spread will be always the volumes of trading and emotions of various traders as well as the trend.

There is often a difference between the rates at which a security trade in Forward Market and spot market. When the securities are trading higher in Forward Market and lower in stock market, such situation is said to be that securities are trading at a premium in Forward Market. When the securities are trading at a higher price in spot market and lower price in Forward Market then We call that the securities are trading at spot market premium or forward market discount.

For example, if Reliance industries is trading at 1150 in spot market and 1160 in forward market then it will be interpreted that Reliance industries is trading at Forward Market premium of 10 rupees. If reliance is trading at 1140 into forward market and 1150 into spot market then it will be said that Reliance industries training at a discount in in forward market.