How financing differs across instruments

One name, three calculations 

On a statement the adjustment goes by one name whatever the position is written on, and that single label causes most of the confusion about it. Behind it there is no single mechanism. Financing exists because a CFD is opened without the full contract value being paid, so something stands in for the money that was not handed over, and what stands in depends on what the contract references. A currency pair is two interest bearing things held against each other. An index or a share is one price, financed in one currency. A commodity contract is often written on a futures contract that expires, which is a different question altogether.

Currencies: the difference between two rates 

A currency pair is a relationship rather than a thing, and a position in one is two positions at once: one currency held, the other owed. Each currency carries a short term interest rate in its own money market, so both rates are live in every FX position, and the adjustment is built from the difference between them. That difference is the interest differential.

The sign follows direction mechanically. Where the currency held carries the higher of the two rates, the differential runs in the position's favour; where it carries the lower, against it. Reversing direction reverses the sign, because it swaps which currency is held and which is owed. That is why a financing credit is structurally ordinary in FX, and this is the one class in this lesson where that is true.

Two steps then sit between the differential and the statement, and neither is the differential. Firms apply an adjustment of their own on top, in the direction that reduces a credit and increases a debit, which is a charge for carrying the position rather than a market rate. The result is applied to the notional value and divided by the day count, because an annual rate has to be reduced to one night before it can be charged for one night.

The two directions are not mirror images, and that is why they are shown together. The differential reverses cleanly, being a subtraction that changes places. The firm's adjustment does not: it runs against the position on both sides, subtracted from a credit and added to a debit. The gap between the two amounts is that adjustment counted twice.

Indices and shares: one currency and a reference rate 

An index or a share is quoted and financed in one currency, so there is no second rate to subtract and no differential. The calculation is built instead on a single short term reference rate for that currency, the rate at which money of it is conventionally priced for very short periods. The reference rate is not the charge. It is the base the charge is quoted against.

Direction changes what happens to that base rather than reversing a sign. A position that gains from a rise is conventionally charged the reference rate plus an adjustment, on the reasoning that an unfunded position is carried on borrowed money. A position that gains from a fall is credited the reference rate minus the adjustment, on the reasoning that notional sale proceeds sit on deposit. The subtraction is the part that surprises readers: where the reference rate is lower than the adjustment the result is negative, and a negative credit is a charge. A financing line that is a debit on both sides of one instrument is the ordinary case whenever short term rates are low.

Neither the position nor the firm's adjustment changed between the two cases. The reference rate fell below the adjustment, and one side crossed from a credit into a charge as a consequence of arithmetic happening somewhere else entirely.

These contracts carry a second adjustment that is not financing and is regularly mistaken for it. When a company goes ex dividend its share price conventionally falls by approximately the distribution, and the contract falls with it, so an adjustment is booked to neutralise a movement that is mechanical. It is calculated from the distribution rather than from a rate, and is indifferent to how long the position has been open.

Commodities: a contract with an end date 

Many commodity contracts are written on a futures contract rather than a spot price, and a futures contract expires. That one fact changes the question. Instead of what it costs to carry an unfunded position one more night, the question is what happens when the contract underneath reaches its last day and is replaced by the next in the calendar.

The two contracts almost never trade at the same price, and the gap is not a market move. A further dated contract carries the cost of storing, insuring and financing a physical commodity to a later delivery date, so it is conventionally the dearer, and that inverts when the market is short of the commodity now rather than later. When the reference switches, the quoted price steps by the difference in an instant, and a cash adjustment is booked against every open position in the opposite direction and the same amount, so the roll produces neither gain nor loss. The position keeps its exposure to price and is insulated from the calendar.

Not every commodity contract behaves this way, and the class name is a poor guide to which does. Spot metals, gold and silver in particular, are conventionally written without an expiry and financed much as a currency pair is, because a metal has a lending rate of its own to set against the currency it is quoted in. Which of the two applies is a property of the individual contract.

Day counts and the weekend 

Two calendar conventions sit inside every calculation above, and both differ by class. The first is the day count. An annual rate is divided by the number of days a year is taken to have, and money markets do not agree on that number: currency conventions frequently use a three hundred and sixty day year, equity conventions three hundred and sixty five. The difference is negligible on one night and not on a quarter.

The second is the weekend. Financing accrues on calendar days, including days on which nothing trades, but is booked only when the market is open, so the closed days are collected on one weekday. Which weekday differs by class, following the settlement convention of the underlying: spot currency conventionally settles two business days forward, pushing the weekend collection onto Wednesday, while other cycles collect it at the end of the week. The multiple appearing once a week is a calendar artefact, not a change in terms.

Where the figure is published 

None of these mechanisms produces a number without the instrument's own terms, and those terms are published per instrument rather than as one figure covering a class. The document carrying them is the contract specification, which also states contract size, quote currency and trading hours. It is reached from the instrument rather than from an account page, on MetaTrader 5 alike, because a financing basis is a property of the instrument and not of the account it is traded through.

Four entries decide what a financing line will be, and a specification states them separately. The basis, which is what this lesson has been about: a differential, a reference rate with an adjustment either side of it, or a rollover. The rate for each direction, because the two are rarely symmetrical and one tells a reader nothing about the other. The day count. And the currency the charge is denominated in, which is not always the currency of the account, in which case a conversion sits between them and carries a cost of its own, treated later in this module.

Where practitioners disagree 

A position whose financing line is a credit is conventionally called a carry position, and a long standing tradition in currency markets treats the differential as something collected over time. The tradition is contested, and the objection is arithmetic. A differential reduced to one night is small next to the distance a pair conventionally travels in a day, so the price risk carried while the credit accrues is the far larger number, and it does not end when the credit does. Differentials are set by central banks, not by the market, so they change without notice and a credit is not a term of the position. This module treats a financing credit as a feature of a cost line rather than a source of return, which is a deliberate limit on what is taught here.

The second disagreement is about disclosure. One position holds that the firm's adjustment belongs on its own line, published apart from the rate it applies to, so the market component and the charged component can be read separately. The other holds that a single figure per instrument per side is more useful, because it is the number actually booked, and a decomposition invites comparison of components not defined identically from one firm to the next. Both are in use, and two published figures cannot be compared unless the basis is stated beside each, the problem this module already met with commission quoted per side and round turn.