This guide is provided by Alt21 Limited, trading as Alt21, an FCA authorised payments and FX provider and is intended for UK businesses considering FX hedging as part of their treasury activity. All examples provided are illustrative only and not a current or guaranteed rate. Please read the full disclaimer at the bottom of the page.
What’s the difference between a spot rate vs forward rate?
The spot rate is the exchange rate available for a transaction taking place now. A forward rate is agreed today for a transaction settling at a future date.
But timing isn’t the only difference. A forward rate can be higher or lower than today’s spot rate, primarily because of the interest rate difference between the two currencies. It isn’t a prediction of where the market is heading.
This guide explains how both rates work, how forward rates are calculated and what to consider when comparing them, with insights from Chris Canning, Vice President of Sales & Trading at Alt21 and Tom Vooght, Head of Sales at Alt21.
As Alt21 employees, their comments throughout this guide reflect their own experience working with Alt21’s clients and describe Alt21’s own products and approach, rather than independent market commentary.
Quick summary
- A spot rate is the current exchange rate used as the basis for a currency transaction settling now or shortly, typically within two working days
- A forward rate is an exchange rate agreed today for a currency transaction that will settle on an agreed future date
- The forward rate isn’t a prediction of future exchange rates. It reflects today’s spot rate, adjusted primarily for the interest rate differential between the two currencies
- Spot transactions are typically used for near-term payments, while forward contracts can be considered when a future currency requirement is sufficiently known, and a business wants greater certainty over the exchange rate.
- Spot and forward transactions can be used together. Businesses don’t necessarily have to choose one approach for all of their currency exposure
What is a spot rate?
A spot rate is the exchange rate for converting one currency into another for near-immediate delivery.
For example, if a UK business needs to convert pounds into euros to pay a supplier, the current spot market provides the starting point for pricing that currency exchange.
At the scale of corporate FX, ‘immediate’ comes with a small technical caveat. Many spot FX trades settle on a T+2 basis, meaning the currencies actually change hands two working days after the trade is agreed rather than at that exact moment.
The spot rate itself moves constantly.
It’s driven by supply and demand in the FX market and can respond to factors including interest rate decisions, inflation data, economic figures and political or geopolitical developments.
If you’ve watched GBP/EUR move over the course of a single day, you’ve seen this in action.
How do you calculate a spot rate?
In practice, you won’t usually need to calculate the spot rate yourself. It reflects the current market price for exchanging one currency for another and changes throughout the trading day.
You can see live or indicative spot rates through your bank, FX provider or financial data sites.
The rate you see on sites such as Google or XE is typically the mid-market rate, which sits between the market’s buy and sell prices. The rate available from your FX provider may differ because it can include a spread or margin.
That difference forms part of the cost of the transaction, which is why it’s useful to look at both the exchange rate you’re offered and any additional fees when comparing the cost of exchanging currency.
What is a forward rate?
A forward rate is the rate you agree today for a currency exchange that will settle on an agreed date in the future, whether that’s next month or in a year’s time. You’re agreeing today to exchange currencies later at a rate fixed in advance.
Say you’re a UK business that owes a French supplier €50,000 in three months. You could wait and buy those euros at whatever the spot rate happens to be when the invoice becomes due. Or you could agree a forward rate today, giving you visibility over the sterling cost of that future payment.
Chris Canning explains the distinction using the same type of example:
“If you get an invoice landed on your desk today, and it’s priced in dollars, you buy the dollars, and you know the cost. If the invoice needs to be paid next month, you’ve no idea today what the cost is going to be next month.”
A forward contract allows the exchange rate for that future transaction to be agreed in advance.
Importantly, a forward rate is not a prediction, forecast, or guess about where the spot rate will be when that date arrives. Nobody, including your FX provider, knows what the future spot rate will actually be.
Instead, the forward rate starts with today’s spot rate and adjusts it primarily to reflect the difference between the interest rates of the two currencies involved.
How do you calculate a forward rate?
As with a spot rate, you won’t usually need to calculate a forward rate yourself. Your bank or FX provider will quote the rate available for the future date you’re looking to exchange currencies.
It is useful, however, to understand where that rate comes from.
At its simplest, a forward rate starts with today’s spot rate and is adjusted using forward points:
Forward rate = spot rate +/- forward points
Forward points are primarily driven by the difference between the interest rates of the two currencies involved. This relationship is based on a principle known as interest rate parity.
The idea is that borrowing and holding money has a different cost in different currencies. If those differences weren’t reflected in forward exchange rates, it could theoretically be possible to borrow in a currency with a lower interest rate, convert the money into a currency with a higher interest rate and benefit from the difference without taking equivalent currency risk.
Forward points account for that difference when determining a rate for a future date.
In practice, this means the forward rate can be either higher or lower than today’s spot rate depending on the currencies involved, their respective interest rates and how far into the future the transaction will take place.
The rate your provider offers may then also include an FX margin, just as it can with a spot transaction. This is why the forward rate you’re quoted may differ from the underlying market forward rate.
Why can a forward rate be higher or lower than the spot rate?
This is where forward pricing can initially feel counterintuitive.
Imagine the GBP/EUR spot rate is 1.1500 (an illustrative figure only and not a current or guaranteed rate), but you ask for a forward quote for a payment due several months from now and receive a different underlying market rate.
It would be easy to interpret that difference as a view on where GBP/EUR is heading.
It isn’t.
As Chris explains, one of the common misconceptions he encounters is simply:
“The mistake they make is not understanding that the forward price may not be the same as the spot price.”
One way to understand why is to think about what happens to the money between now and the future settlement date.
If you hold pounds today but don’t need euros until several months from now, you can continue holding those pounds during that period. At the same time, you don’t yet hold the euros.
Those two currencies may have different interest rates, meaning the economic value of holding one rather than the other changes over time.
As Chris puts it:
“You’re gaining on your pounds interest, but you’re losing your euros interest. So coming a year’s time, it’s those two rates divided by each other.”
The precise calculation is more technical, but the important point is straightforward:
Forward points account for the interest rate differential between the currencies over the period of the contract.
The larger the interest rate differential, and the further away the settlement date, the more noticeable the difference between the spot and forward rates can become.
So, if a forward rate looks less favourable than today’s spot rate, that doesn’t automatically mean the provider expects the currency to weaken or that the forward itself is more expensive. Part of the difference may simply be the forward points.
Any provider margin should be considered separately when looking at the rate actually offered.
Spot rate vs forward rate: key differences
| Spot rate | Forward rate | |
| When the rate is agreed | When you make the transaction | In advance of a future transaction |
| When you settle | Typically within two business days | On an agreed future date or within an agreed window |
| How the rate is determined | Based on the current market exchange rate | Based on the spot rate, adjusted using forward points |
| Exposure to future rate movements | The transaction takes place at the rate available at the time | The agreed rate applies even if the market moves before settlement |
| When businesses might use it | Payments being made now or in the near term | Future payments where the amount and timing are sufficiently known |
The main difference between a spot rate and a forward rate is when you need to exchange the currency.
A spot transaction uses the exchange rate available when you make the trade, so it can work well for payments that need to be made now or shortly.
A forward contract works differently. It’s a binding commitment. Once agreed, the business is obliged to transact at that rate even if the market subsequently moves in its favour. Forward contracts may also carry margin requirements and counterparty risk.
The two don’t necessarily have to be used in isolation, either.
Some businesses use a combination of spot transactions and forward contracts as part of their wider approach to managing currency exposure. The appropriate mix will depend on factors such as the timing and predictability of cash flows, the amount of exposure and the business’s objectives.
A spot rate vs forward rate worked example:
Let’s return to our UK business with a €50,000 supplier invoice due in three months.
For simplicity, imagine today’s GBP/EUR spot rate is 1.1500.
If the invoice were due today and the business exchanged currency at that illustrative rate, €50,000 would cost approximately:
€50,000 ÷ 1.1500 = £43,478
But the invoice isn’t due today. It’s due in three months.
Suppose the underlying three-month forward rate is 1.1450 after the applicable forward points have been taken into account.
At that illustrative forward rate:
€50,000 ÷ 1.1450 = £43,668
At first glance, you might ask why the forward rate is 1.1450 when the spot rate is 1.1500.
The answer isn’t that the market has predicted GBP/EUR will fall to 1.1450 in three months. The difference reflects the interest rate differential between sterling and the euro over that period.
If the business enters into the forward contract, the agreed rate then applies to the future transaction regardless of where the spot market subsequently moves.
If it waits instead, the sterling cost of the invoice will depend on the spot rate available when payment is due.
These rates and calculations are illustrative only and exclude provider margins and other potential transaction costs. They do not represent current or guaranteed rates, and actual pricing will depend on market conditions and the terms of the transaction.
Spot or forward: What should a business consider?
There isn’t one answer that applies to every currency transaction.
Whether a business uses the spot market, a forward contract or a combination of the two will depend on its circumstances.
Some of the factors worth considering include:
When does the payment need to be made?
If currency needs to be exchanged immediately or within the next few days, a spot transaction may be appropriate.
A forward contract becomes relevant when the business has a currency requirement that will settle further into the future.
How certain is the future payment?
The amount and timing of the exposure matter.
A confirmed supplier invoice due in three months provides considerably more visibility than a possible order that may or may not happen later in the year.
That doesn’t necessarily mean a business needs complete visibility over every future payment before it can consider hedging.
Tom says one misconception he regularly encounters is the assumption that entering into forwards means covering all expected exposure:
“They always think that they have to hedge all of their exposure.”
In practice, businesses can use different approaches for different portions of their currency requirements.
You may be interested in our article on why currency hedging still feels too complex for SMEs.
How important is knowing the exchange rate in advance?
For some businesses, fluctuations in currency costs can be absorbed relatively easily.
For others, knowing the exchange rate for an upcoming supplier payment, payroll run, or other known cost can make budgeting and forecasting easier.
The question is therefore not simply whether the market might move favourably or unfavourably, but how much visibility the business needs over that particular future cost.
Could margin requirements affect cash flow?
Depending on the provider and terms of the forward contract, a business may need to provide initial or variation margin.
That can affect working capital during the life of the contract and should form part of the decision rather than being considered only after a forward has been booked.
Understanding the provider’s margin terms before agreeing is important.
Does it have to be spot or forward?
Not necessarily.
A business might use a forward contract for part of a sufficiently predictable future exposure while leaving another portion to be exchanged later.
How much, if any, exposure a business chooses to hedge will depend on factors including its cash flows, objectives, forecast accuracy and risk parameters.
Common misconceptions about spot and forward rates
Understanding the mechanics is one thing. Knowing what the numbers do and don’t tell you is just as important.
Here are some of the misconceptions Chris and Tom encounter when discussing forwards with businesses.
“The forward rate tells me where the spot rate will be in the future”
It doesn’t.
A forward exchange rate vs spot exchange rate comparison shows you the rate available for two different settlement dates.
The forward rate is calculated using today’s spot rate and forward points, which primarily reflect the interest rate differential between the two currencies.
The actual future spot rate remains unknown.
“A worse forward rate means I’m being charged more”
Not necessarily.
If the underlying forward rate differs from the spot rate, some or all of that difference may come from forward points rather than the provider’s margin.
That distinction matters when comparing FX quotes.
The underlying market forward rate and the rate ultimately offered by your provider are not necessarily the same thing. Asking how the rate has been constructed can give you a clearer picture of what you’re paying.
“If I use forwards, I need to hedge everything”
Using forward contracts doesn’t automatically mean covering 100% of expected currency exposure.
Some businesses combine forwards with spot transactions or build their hedging over time.
The approach depends on the predictability of the exposure, cash flows and wider business objectives.
“Booking a forward is much more complicated than making a spot transaction”
The mechanics are different, but that doesn’t necessarily mean the process of booking one needs to be significantly more time-consuming.
Chris recalls speaking to one Alt21 client who had assumed hedging would require considerably more work than its existing spot transactions:
“In practice, booking a forward doesn’t typically take much longer than a spot transaction.” *Individual client experiences can vary.
The more important difference is the commitment being made.
With a spot transaction, the currency is being exchanged now or shortly. With a forward, the business is agreeing today to transact at a future date.
Spot today or forward tomorrow?
Understanding the difference between spot and forward rates isn’t really about deciding which rate is ‘better’. They serve different purposes.
A spot rate tells you what exchanging currency costs today. A forward rate gives you a rate for an agreed future transaction. Whether a business uses one, the other, or a combination will depend on its upcoming payments, cash flows and wider approach to managing currency exposure.
The important part is understanding what sits behind the rate you’re being quoted. Forward points, provider margins and the terms of a forward contract can all affect what you ultimately agree to.
See the numbers for yourself
Want to put that into practice?
Alt21’s Price Your Trade calculator lets you explore indicative pricing for your currency requirements and see what a potential trade could look like.
Rates shown are indicative only and may differ from the rate available when you transact.
ALT21 Limited is authorised and regulated by the Financial Conduct Authority (FRN: 783837) and is a company registered in England and Wales (number 10723112). The registered address is 45 Eagle Street, London WC1R 4FS, United Kingdom. This article has been produced by ALT21 Limited for information purposes only. It does not constitute financial advice or an offer to sell or the solicitation of an offer to buy any products referenced. Hedging products are not suitable for every business. Before entering into any FX product, you should consider whether it is appropriate for your needs and circumstances. ALT21 Limited assumes no liability for errors, inaccuracies or omissions. Eligibility criteria and terms and conditions apply to all products and services offered by ALT21 Limited. Not all applications will be accepted.
