In finance, a contract settles when one or both parties perform on an obligation under that contract. The term is commonly used in trading and derivatives markets. In trading, a trade settles when the instrument being traded actually changes hands and/or is paid for. Both events typically occur on the same date, which is called the settlement date. Because of mistakes or events beyond the control of
counterparties, transactions sometimes fail to settle on the intended
date. For this reason, it is useful to distinguish between a transaction's
When a market value is calculated for an instrument, this is typically as of the value date. In this way, the market value reflects the value that the instrument would command in the market for payment and delivery on the value date. If an entire portfolio must be marked to market, some common value date is assumed for all instruments.
A trade is
spot settled if the
Spot
A trade is forward settled
if it settles on some date after spot. Forward transactions, called
forward contracts of
forwards, routinely have
If a trade has a cash, spot or forward value date, it may be called a cash, spot or forward trade. Prices at which cash, spot and forward trades transact are called cash prices, spot prices and forward prices. In the debt markets, a loan is agreed to on one date but it is said to settle on the date the loan commences. Analogous to trading, there are cash loans, spot loans and forward loans. For example, in the Eurodollar markets, spot deposits settle in two trading days. Forward deposits settle after that. If interest rates are fixed at the time loans are agreed to, interest rates will differ for spot or forward loans. For example, the interest rate on a 3-month spot loan will generally differ from that on a 3-month forward loan commencing in a year. Accordingly, the markets distinguish between spot interest rates and forward interest rates. See also the article forward rate agreement. In the money markets and foreign exchange markets, very short-term loans are used to manage short-term cash flows. An overnight loan commences immediately and lasts for one trading day. A tom-next ("tomorrow-next") loan commences in one trading day and lasts for one trading day. A spot-next loan commences in two trading days (spot) and lasts for one trading day. In commodity markets, physical commodity trades settle in several ways. While specifics vary from one market to another, some standard methods are:
In the context of derivatives, a derivative settles when one or both parties perform on an obligation under the derivative contract. For example, a swap contract calls for periodic payments to be made between two parties. The swap settles each time a payment is made. Margin is paid on futures contracts every trading day. Accordingly, futures settle daily. Consider an OTC call option on oil. If exercised, the option settles when the oil is delivered and/or payment is made for the oil. Trading organizations have a back office (or operations department). One of this department's purposes is to settle trades and/or other obligations on behalf of the organization.
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