Spot Rates

What is Spot Rate?

The spot rate is the rate of interest earned when cash is received only once in the future. The zero-coupon interest rate, or simply the “zero,” is another name for it. Spot rates give the same information as discount factors.

Example of Spot Rates:

The spot rate is the current price quoted for the contract’s immediate settlement. For example, if a wholesale corporation needs orange juice supplied immediately in August, it will pay the spot price to the vendor and receive orange juice within two days.

Suppose you invest USD 100 today and repay USD 120 in three years with no intermediate payments. The three-year spot rate is the rate that equates to USD 120 in three years with USD 100 today. If the rate R is measured with annual compounding, it is given by solving

100(1 + R)^{^}3 = 120

Why are Spot Rates important?

Because a commodity, security, or currency’s predicted future value depends partly on its present value and in part on the risk-free rate and the period until the contract matures, the spot rate is used to determine a forward rate—the price of a future financial transaction.