An act of reaching an agreement is outlined as a settlement

The settlement date in a bond is the day on which the trade is finalized. The buyer makes the payment to the seller when the assets are delivered to the buyer.

The settlement date in bonds or stocks is usually two business days after the execution date. It is called termed as (T+2) days

However, for government securities, it is the following business day (T+1). In regards to forex exchange, the settlement date is two business days after the transaction date.

The settlement date for securities ranges from one day to three days, depending upon the type of securities.

Eg: If an investor buys a bond from company XYZ on Monday with a T+2 settlement date, it means the transaction will be completed in two business days. If there is no public holiday coming in between the two exchanges then the transaction will be completed on Wednesday. It is the date when the buyer receives the securities in his hand.

Similarly, if the buyer initiates a trade with the seller on Friday with a T+2 settlement date then the transaction will be settled on Tuesday. The settlement date excludes weekends and hence Monday and Tuesday will be considered as business days.

The lag between the settlement date between the buyer and the seller expose them to certain risks:

Credit risk- The risk refers to the loss ensuing if the buyer fails to meet the legal obligations of the trade. It occurs due to the elapsed time between the two dates and the volatility of the market. This means that the buyer may fail to make the agreed payment by the settlement date to the seller causing an interruption in the seller’s cash flows.

Settlement risk- The risk occurs if either of the parties in an agreement fails to fulfill their respective part of the agreement. It occurs when the seller fails to deliver the underlying asset, such as a bond or a stock to the buyer in exchange for payment of the securities.

On the other hand, the risk may occur if the buyer fails to make the payment to the seller after the securities are delivered to the buyer. Transactions across different geographical locations or different time zones are also affected by the settlement risk.

The importance is determined on the following factors:

Regulation- As per the regulative bodies, the potential emptor cannot resell the particular securities until the trade settlement whereas the seller cannot use the funds to be received from the buyer for buying any other securities until the trade settlement. The date is highly crucial for both the buyers and sellers of the assets.

Accounting- In the case of accounting, the transaction reflects within the trader’s record solely when the trade is finally settled. Thus in the case of month-end transactions, there is a likelihood that the trading month will be different from the transaction date accounting.

Bottomline

The settlement date provides sufficient time for clearing firms to ensure that transfer of shares and cash are done in accurate accounts. The transfer agent of the company that issued the traded securities updates its records to reflect the change of ownership. It is an important aspect of any transaction as it reveals when the trade is settled which is after certain days from the trading date.