The overnight interest rate results from 24-hour forex trading with product and transaction delivery times, linked to delivery dates.
During foreign exchange trading, traders may find that in addition to handling fees and trading profits and losses, there are also storage fees or interest, commonly known as overnight interest. The following will introduce the meaning and calculation formula of overnight interest to help traders better conduct trading.
The meaning of overnight interest
Overnight interest refers to the fact that in foreign exchange trading, positions must be delivered after two trading days. Position is a market agreement that promises to buy and sell the initial position of a contract, and the buyer of the contract is a long position, in a bullish position; The seller of the contract is a bear and in a bearish position.
The relevant positions usually do not maintain the same interest rate swap points, which are based on the relevant currency combination. The overnight swap interest varies between the two currencies and fluctuates with daily price changes. Foreign exchange refers to the creditor's rights held by monetary administrative authorities (central banks, monetary management agencies, foreign exchange stabilization funds, and the Ministry of Finance) in the form of bank deposits, Treasury bills of the Ministry of Finance, short-term and short-term government securities, etc., which can be used in the event of an international balance of payments deficit.
Why is there overnight interest?
Usually, we pay interest when we deposit money in the bank, and when we borrow money from the bank, we also need to pay interest. Different currencies have different interest rates. When trading currency pairs, we usually involve two currencies, such as the highest overnight interest rate foreign exchange trader in EURUSD, which involves the euro and the US dollar. In fact, when we buy EURUSD, we buy (similar to a deposit) EURUSD and sell (similar to a loan) USD. Therefore, when the interest rates of these two varieties are different, there will be a difference in interest rates. This generates overnight interest.
Every product and transaction has a delivery time, and the overnight interest rate is also related to the delivery date. In spot foreign exchange trading, delivery must be made after two trading days, and the overnight interest rate is calculated based on the closing time of the New York market (the closing time of the New York market is 5:00 pm, which is 5:00 am Beijing time, and 6:00 am winter time). If we open our position on Wednesday, the delivery date will be on Friday. (In addition, due to weekend holidays, the weekend shipment date will be postponed to next Monday.)
Usually, if we hold a position overnight, there will be overnight interest. Of course, there is no overnight interest in opening and closing positions on the same day.
Wednesday's triple interest rate
Because weekends are usually a break time, banks are not open. But banks that hold positions on weekends still calculate interest as accountants. In addition, since the delivery date is 2 days later, if there are still positions on Wednesday, overnight interest for 2 days needs to be calculated on weekends. So if you hold a position overnight on Wednesday, the overnight interest rate is usually three times that of other trading days.
Why is it Wednesday?
This is mainly because, according to international practice, foreign exchange traders with the highest overnight interest rates settle their transactions after 2 trading days.
Monday: 1-day overnight interest. Trading on Monday, settlement on Wednesday, holding positions from Monday to Tuesday, and settlement from Wednesday to Thursday will result in 1-day interest.
Tuesday: 1-day overnight interest. The holding time is from Tuesday to Wednesday, and the settlement date is from Thursday to Friday, so one day of interest needs to be paid or charged.
Wednesday: 3-day overnight interest. The holding time is from Wednesday to Thursday, and the settlement day is from Friday to next Monday, so three days of interest need to be paid or charged.
Thursday: 1-day overnight interest. The holding time is from Thursday to Friday, and the settlement day is from next Monday to next Tuesday, so 1 day of interest is required to be paid or charged.
Friday: 1-day overnight interest. Hold the position from Friday to next Monday, with settlement days from Tuesday to Wednesday, so only one day's interest will be paid or charged.
In addition, for certain currencies such as the Canadian dollar, lira, ruble, etc., some brokers calculate triple overnight interest rates on Thursday.
Positive or negative overnight interest
Overnight interest will be generated when customers hold positions overnight. The overnight interest rate can be positive or negative, with a positive or negative sign representing the premium or discount between the one-day forward exchange rate and the spot exchange rate. We can consider a positive value as a trader receiving a certain amount of overnight interest, while a negative value is considered as a trader paying a certain amount of overnight interest.
So why are there positives and negatives?
It is generally believed that a positive value indicates that a certain amount of overnight interest can be obtained, while a negative value indicates that a certain amount of overnight interest needs to be paid. But this is only displayed by the trading system for the convenience of customers. It is wrong to conceptually understand the positive or negative value of overnight foreign exchange interest.
There are many calculation factors included in this, such as the T/N of the next day's trading, the bid/offer price quoted by the trader for the currency pair during settlement, and the bid/offer price quoted by the LP. If there are too many calculation results and the short position is both positive and negative, the high-interest currency long position will receive interest. Conversely, if the calculation results are positive or negative, both long and short positions will receive interest payments.
Positive and negative numbers represent the cost of the swap spread from this value date to the next value date, rather than the direction in which the customer pays interest. Positive and negative numbers represent the cost of the swap spread from this value date to the next value date, rather than the direction in which the customer pays interest. At present, most currency pairs require payment from both customers, even if one of the currency pairs has a slightly higher interest rate, because the interest rate difference itself is very small, the interest rate difference is extremely narrow, and the cost of the banker's interest rate difference is slightly lower in Ringgit. The high-interest currency has changed when the customer can receive interest, and this cost is added, resulting in both parties having to pay interest. This is normal because retail costs are always higher than interbank costs. Currently, only a small number of currency pairs with large interest rate spreads will receive interest rates when they are long in high-interest currencies, such as the Australian dollar, against low- or zero-interest currencies.
Assuming that the euro interest rate is 1% and the US dollar interest rate is 0.25%, traders buy euros and receive 1% annualized interest, but they also sell dollars. The US dollars are lent to traders by foreign exchange brokers, who charge interest (some foreign exchange brokers charge low interest, while others charge high interest). Assuming that foreign exchange brokers charge interest of 1.5% plus the original interest rate of 0.25% in the US dollar, traders need to pay a total of 0.75% interest.
Formula for calculating overnight interest
The basic formula for calculating overnight interest is: the actual number of orders × Standard for one hand × Exchange rate price (different prices for empty and multiple) × Interest Days × Annual interest rate difference/360 days.
It can be divided into
Currency combinations targeting the US dollar
For example, assuming a 100000 (1 standard hand) account, buy 2 hands of GBP/USD on Monday at a market price of 1.2928/1.2940, holding overnight until Tuesday. Here, GBP is a high-interest-rate currency, while USD has a lower interest rate than GBP. For example, if the interest rate difference is 0.42% (the annual interest rate difference), investors holding GBP will profit.
Calculation method: 10000 × 2 hands × one point two nine four zero × 1 day × 0.42%/360=$3.02, which means the average annual interest rate is days × Corresponding account funds × Hand count × Buying and selling price × Interest rate days.
A combination of US dollars as the benchmark currency
For example, for USD/JPY, assuming a 10,000 (1 standard hand) account, selling 1 USD/JPY on Wednesday at a market price of 107.44/107.47, holding overnight until Thursday, with an interest margin of -2.18, investors selling USD/JPY need to pay interest.
Calculation method: 10000 × 1 hand × 3 days × (-2). 18%/360)=$18.17 (Special note: there is a warehouse on Wednesday until Thursday, and the overnight interest is three times higher than usual.) Since the delivery actually occurs next Monday, it is every two days.
For example, for a EUR/GBP account of 100000 (1 standard hand), if you purchase 5 EUR/GBP on Friday, the market price is 0.6885/0.6890, and you hold the position overnight until next Monday, the interest difference is -3.71. Investors who purchase EUR or GBP need to pay interest.
The calculation method is: 000 × 5 hands × 0.6890x1 day × (-3.71%/360=(0). 355)=($0.63)
If investors create many high-interest currencies, the overnight interest rate that has not been liquidated will be added to the account's funds, and on the contrary, the relevant overnight interest will be deducted from the funds.
Overnight interest plays an important role in foreign exchange trading. Through the above content, traders can understand the meaning and calculation formula of overnight interest, consider the impact of overnight interest based on the selected currency pair, position, and time, and effectively manage foreign exchange positions and risks.
Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.