Question

Explain the difference between the spot rate, the forward rate, the real exchange rate, and the effective exchange rate.  Then discuss a situation in which you would use each of these different exchange rates.

I need a clear discussion about a situation and clear explanation. Thanks

Answer 1

Spot rate is a contracted price which is for immediate delivery and payment on the spot date. while, forward rate is a contracted price for transactions that would be completed at some future date which was agreed upon.The spot rate is the basis for the future rate while the future rate is not the basis for the spot rate so we can say that the future rate is dependent upon the spot rate.

the real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in the foreign country, while the effective rate is the weighted average of countries currency, relative to an index or basket of other currencies adjusted with the effect of inflation. We can say that the real exchange rate does not account for inflation while the effective exchange rate account for inflation.

spot rate can be used while trading into a cash market while future rates can be used while trading into derivatives.real rate can be used while trading into foreign market where there is no need for inflation adjustment, while effective exchange rate can only be used where there is weighted inflation in place in exchange markets.