Purchasing a Contract For Difference is so appealing due to the small capital required to assume a large position. In many cases only 5% capital is required as margin. This means that someone else is tying up large amounts of money to give you such massive leverage. It would be unfair to borrow money and not pay them interest on their capital. This is why we must pay overnight financing fees on long or bullish CFD’s.
Getting and Receiving Interest on CFD’s
Before we calculate the fees we need to understand a few criteria:
- We only pay the financing fees if the position is held overnight
- Interest is paid on the entire asset amount
- If we have a long position with a CFD, we pay interest
- If we have a short position with a CFD, we receive interest
If we trade our CFD intra-day, we do not pay financing fees. As well, how much margin we have does not matter, we generally need to pay interest on the full asset amount.
Notice that a long position, or a purchase of a CFD that we anticipate rising in value, will accrue interest charges that we need to pay out. On the other hand, if you hold a short position, you will receive daily interest.
How much will we pay or receive with daily interest financing charges?
Calculating the Bench Rate
To determine our daily financing rate we first need an agreed upon benchmark. In Australia this will typically be the Reserve Bank of Australia Interbank Overnight Cash Rate (RBAIOCR).
The Reserve Bank of Australia sets the target rate, and works on the open market to ensure the actual rate is as close as possible to theirs.
But this rate is not the actual rate which your CFD provider will request financing fees and pay you interest. The provider will no doubt want to take their own cut or percentage as well.
Adding on Commissions and Fees
Even though your transaction is between an asset holder (CFD writer) and yourself (CFD purchaser), the middle man who is facilitating the transaction will also require a percentage. They may add a percent or two onto your required overnight financing, or shave a percent or two off the interest you have coming.
Below is the statistics on overnight financing from one prominent CFD provider.
|Reserve Bank cash rate plus 2% - 4%
||Reserve Bank cash rate minus 2% - 3%
Example: Calculating Total Overnight Financing Fees
Next we will calculate our total daily overnight financing fees (interest fees) with the following criteria:
- We will assume the Australian RBA Cash Rate Target to be 4%.
- We purchase 1,000 CFD’s
- The underlying asset is worth $10 per share
- Our CFD provider adds 3% interest rate on all fees
Now we can determine our total asset worth and the combined financing costs owing.
- Asset worth: 1,000 x $10 = $10,000
- Annual Financing Costs: 4% + 3% = 7%
- Daily Rate: 7% / 365 days per year = 0.0192% daily
- Daily Financing Costs: $10,000 x 0.0192% = $1.92 daily charges
From this calculation we determine that an overnight position on $10,000 will cost us $1.92. How much will we receive if we hold a short position with the same criteria?
- Annual Interest Rate: 4% - 3% = 1% interest paid
- Daily Rate: 1% / 365 days per year = 0.0027% daily interest
- Daily Interest Accrued: $10,000 x 0.0027% = 0.27 cents
As we can see, the middle man takes such a large cut that the return is almost negligible. If we wanted to accrue interest only, our money is better kept in the bank than in short position CFD’s.