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Typically, a currency pair trade is settled within two business days. However, it’s possible to extend the position through another two trading days by holding it open to the next day. This is called a “rollover.”
Why Does Rollover Interest Exist
All Forex trading is done in currency pairs. Each currency in that pair has a short term interest rate, this is the interest rate at which banks in the currency’s home country lend that same currency to other banks overnight.
When a currency position rollovers, the difference between the amount of interest being earned on the base currency against the amount of interest being paid on the quote currency is the rollover interest.
What Makes Rollover Interest a Credit or Debit
You’ll be credited or debited the rollover interest depending on whether the short term interest rate on your base currency is higher or lower than the quote currency’s short term interest rate. If the base currency short term interest rate is higher, the rollover interest is a credit. However, if the quote currency has the higher short term interest rate, the rollover interest is a debit.
When Does Rollover Interest Arise
The timing on rollover interest is very precise. Any currency positions that remain open as of 5 p.m. EST are deemed to be held overnight and so rollover interest applies.
Even though banks don’t operate on weekends or holidays, rollover interest will still be applied on an open position. Since spot trading takes two days to settle, trades held open on Wednesdays may book three days of rollover. Brokers do have their own rollover interest policies.
How is Rollover Interest Calculated
The first important note to understand is that rollover interest is based on the total value of the trade, not just the margin. You need three pieces of information in order to calculate rollover interest:
– the total amount of the trade
– the price quote of the currency pair
– the short term interest rates for both currencies in the pair
Using entirely fictitious numbers, suppose your position controls $100,000 EUR/USD. This is the total amount of the trade.
The next step is to find the short term interest rates for each currency. For purposes of this example, pretend the short term rate on the euro is one percent and for the U.S. dollar, it’s 0.25 percent.
The final piece of information is the price quote on the currency pair, say EUR/USD 1.3229.
To calculate the daily rollover interest rate, take the difference between the two interest rates. Here, that’s 0.75 percent. Then, multiply the interest differential by the total value of the trade: $100,000 x 0.75 percent = $75,000. Now, multiply the price quote by the number of days in the year: 1.3229 x 365 = 482.8585.
The final step is to divide the first number by the second number: $75,000/482.8585 = $153.33. This makes the $153.33 the daily rollover interest. The rollover interest in this scenario is a credit since the euro’s short term interest rate was the higher one.
Written as a formula, the calculation is:
[trade value x (base currency interest rate – quote currency interest rate)]/(365 x currency pair’s price quote)