A spread in financial markets is the difference between the bid price (the price that buyers are prepared to pay) and the offer price (the price which sellers are prepared to sell at) on a financial or investment product.
Whilst the term “spread” is widely used in finance, the term discount spread is specifically related the foreign exchange markets. The foreign exchange market has what is known as a spot rate which is the rate at which currencies can be traded at a specific time (the rate will vary throughout the day) during the current trading day. Discount spreads occur on contracts for future exchanges. This means that the parties agree today to buy and sell a specific currency at a specific rate at a specific future date. The discount spread arises due to the time value of money. This theory postulates that holing the cash will allow the investor to earn interest over time on this cash and this interest value must be taken into account in making trades which will mature in the future.
If the trade concerned is a Euro / United States Dollar trade and the Euro interest rates are higher than those in the United States, this will give rise to a discount spread which will cause the bid price to be higher than the offer price. The converse of this situation is known as a premium spread.
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