Forex Call: How to Calculate Funding Rates on …
When a foreign exchange position is carried over overnight, the position is adjusted to reflect the interest rate differential between the two currencies. Learn how the forex rollover works.
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Key points to remember
- The finance rate (also known as the “rollover rate” or “rollover rate”) is the interest you pay or earn for holding a spot currency overnight.
- The rate of a currency pair is based on the interbank interest rate differential between the two currencies.
- The current rate for each currency pair listed on the thinkorswim® platform can be found under the heading MarketWatch tongue
Suppose you have decided to venture into retail forex investing. You buy a foreign currency and hold the position for about a week.
After a few days, you start to notice something: Your “open” position appears to be accumulating credits (or debits) at the end of each business day. Later in the week, you notice that your account has been credited (or debited) three times the apparently fixed amount.
You begin to realize that over time these additional credits or debits could add up to a much larger amount, which can alter the value of your investment.
What are these small credits and debits? And why are they happening? Welcome to your first encounter with forex finance rates.
Do I pay or earn interest on my currencies?
A finance rate (also called a “rollover rate” or “rollover rate”) is the interest you pay or earn for holding a spot currency overnight. These rates are not based on central bank rates. Rather, they are interbank rates: the rates that banks apply when they lend money to each other.
Whenever you trade a currency pair, you are essentially “long” on one currency and “short” on the other. Each currency in a pair has an interbank interest rate. You earn interest on the currency you are long on, and you pay interest on the currency for which you are overdrawn. The differential between the two interest rates is your net finance rate.
So if your long currency has a higher interest rate than the currency you’re selling for, your net finance rate would produce a credit (a “positive roll”). The reverse scenario would result in a debit (a “negative roll”).
Here is a hypothetical example: Your forex account is in US dollars. This means that all of your profit and loss, regardless of which currency pair you are trading, will be converted to USD. Suppose you have a long position of 100,000 EUR / USD at the rate of 1.2000. This means that you are long on the euro (100,000 €) and short on its equivalent in USD (120,000 $).
Suppose the euro interest rate is 1.25% (an annual rate, which translates to a daily rate of 1.25% / 365 = 0.0034%), and the US dollar has an interest rate of 3% (which translates to a daily rate of 3% / 365 = 0.0082%). Note: These are hypothetical, not real rates).
- The daily interest on the Euro would be (100,000 x 0.000034) = € 3.40, that’s what you would earn.
- The daily dollar interest would be (120,000 x 0.00082) = $ 9.84 – that’s what you would pay.
- Now let’s convert € 3.40 to USD in order to calculate the funding rate in USD: € 3.40 x 1.2000 (the exchange rate) = $ 4.08.
- To calculate your net finance rate, subtract the interest you would pay from the interest you would earn: $ 4.08 – $ 9.84 = net finance rate of $ 5.76.
Your account would be debited $ 5.76 for holding your position of 100,000 EUR / USD for one business day. Note: This particular example illustrates a negative result. Each currency pair has a different interest rate differential, so some currency pairs can generate net credit while others can generate net debit.
The main point: The finance rate credits and debits will add up, so it’s important to understand how they will impact your position over an extended period of time. Another important thing to note is that financing rates are not necessarily fixed. You will need to monitor rates constantly to be aware of any changes in interest.
When do funding rates apply to my account?
If your open position is held until the close of the trading day, which is 5 p.m. ET, your position will go through funding.
Funding credits and debits are applied to your account generally between 5:15 p.m. and 5:30 p.m. ET. Funding rates are calculated over 365 days, so weekends and holidays are factored into the funding calculation.
In general, Wednesday’s finance calculations will be three times (“3X”) the normal daily finance calculations, as Wednesdays are typically used to count weekends. The funding Wednesday 3X is not fixed, however; holidays, for example, may change the funding schedule. If you are unsure of when or how funding is calculated, it is always a good idea to check with your broker’s schedule to see how and when funding rates will be applied to your account.
Where can I find the funding rates for each currency pair?
TD Ameritrade clients can view the funding rate for each currency pair rate on the thinkorswim® platform. Under the MarketWatch tab, select Financing rate (see figure 1).
Selection Financing rate will display a grid showing the long and short rates for each currency pair listed on thinkorswim (see Figure 2). To note: These rates are an example of a guideline. Actual rates may vary.
Conclusion on Forex Funding and Rolling
Retail forex investing can seem complicated at first. But if you take the time to learn the fundamentals, you may find that the forex markets are accessible and full of opportunities.
Refer to this Forex Introduction to learn more about forex. Keep in mind that forex trading involves leverage, carries a high level of risk, and is not suitable for all investors. Please read the full risk information below to help you determine if forex is suitable for your investment objectives and risk / reward profile.
And if you want to deepen your knowledge of forex, you can watch the video below, which explains interest rate differentials and how a “carry trade” can be built in the forex market.
Doug Ashburn is not a representative of TD Ameritrade, Inc. The materials, views and opinions expressed in this article are solely those of the author and may not reflect those owned by TD Ameritrade, Inc.