Earn Interest In Forex
The currency market is designed to facilitate the trade of money between two parties interested in actually delivering the currency being traded. The contracts traded on the spot market are designed to settle within two business days. Since most currency trades are speculative and traders do not want an armored car full of money to show up at their house, currency dealers automatically expire open positions and roll their settlement date forward two more business days. This process, known as the rollover, takes place at the end of each trading day, around 5:00 P.M. Eastern Time. Avoiding settlement is just one benefit; the rollover process also settles interest payments to your account, depending on your open positions. Earning interest for simply holding a position open is a benefit of trading money. Each currency pair has an associated cost-of-carry premium, which is either positive to your account or negative, depending on whether you are long or short. The premium is determined roughly from the central bank rates in the currency’s home country. For example, if you are long AUD/USD while the central bank rate in Australia is 3.5 percent and the central bank rate in the United States is 0.25 percent, you should expect to be paid some of the difference between these two interest rates as calculated on the total size of your open trade. If you were short AUD/USD in this example, you should expect the difference to be debited to your account. There are some variables that affect the actual interest payment paid or charged to your account.
The actual interest rate used to calculate carry premiums is the London Interbank Offered Rate (LIBOR). This short-term interest rate is a benchmark rate maintained on 10 currencies by the British Bankers Association (BBA). The rates are determined through a survey process conducted by the BBA of 8 to 16 contributing banks per currency. The survey determines the lowest average rate at which banks are willing to borrow funds overnight and performs a calculation on that data to determine the LIBOR. The difference in LIBOR rates between two currencies determines the base cost of carry for your open position in the forex market. If you are interested in the specific details of how LIBOR is calculated, I recommend you visit the LIBOR web site at www.bbalibor.com.
Let’s look at an example to understand how the carry premium is calculated using the LIBOR during the nightly rollover.
Assume that you have bought 100,000 units of GBP/USD. In this trade you are buying the British pound and selling the U.S. dollar. If the LIBOR for GBP is 2.4775 percent and the LIBOR for USD is 2.07 percent, the difference between the two currencies is 0.4075 percent. The difference is multiplied by your total position size, in this case, 100,000 × 0.004075, which equals 407.5 units of currency. LIBOR rates are annual yields; therefore, 407.5 represents the annual yield. Divide 407.5 by 360 days to determine the nightly interest premium, which is 1.13 units of currency. If the base currency in your trade is different than the currency your account is funded in, you must also multiply the interest payment by the currency exchange rate to convert the interest payment to your account’s currency. The current GBP/USD exchange rate is $1.5928. The final calculation to convert 1.13 to dollars is 1.13 × 1.5928, which equals a final nightly premium of 1.79 units of currency.
The amount actually charged or credited to your position may vary by broker because many brokers derive income from the overnight swap payments before passing those rates on to you. Brokers routinely publish their swap rates for each currency and typically post them on their web sites. Traders should be aware of these rates and understand that holding a position against the carry could cause them to pay significant interest if they plan to hold the position open for a long period of time. Finally, traders should be aware that on Wednesdays the interest premium is triple the normal amount. This accounts for positions that are set to be settled on Saturdays or Sundays, when the market is essentially closed, by setting their valuation date to Mondays.
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Forex
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