Which markets are impacted by cost of carry?
Forex and commodities are the main markets which are affected by cost of carry, but financial products such as derivatives can be affected as well. Each of these incur different forms of cost of carry. For example, forex transactions might be subject to overnight funding charges as well as fees if the interest rate changes.
Commodities might incur cost of carry charges for the transport, storage and insurance of the asset – assuming that a trader takes ownership of the commodities which they have a position on.
Derivatives such as CFDs incur cost of carry as overnight funding fees. At IG Bank, we make an interest adjustment to your account to reflect the cost of funding your position. We debit your account if the position is long, and we credit your account if the position is short.
Cost of carry in forex trading
With IG Bank, the cost of carry on forex trading is slightly different to the rest of our offering. For one, we will charge you funding costs based on the current tom-next rate, which shows the difference – in points – between the interest paid to borrow the currency that is being notionally sold, and the interest received from holding the currency.
Cost of carry futures calculation
For futures contracts, a special calculation is required in order to calculate the cost of carry. This is because futures incorporate the storage costs associated with the commodity in question, as well as the risk-free interest rate – the rate of return on an investment which has no risk of financial loss. This is a hypothetical concept, since all trades and investments involve some risk of loss, no matter how negligible that may be. However, for practical purposes the rate available on a low-risk government bond is often used.
In the calculation below, ‘convenience yield’ refers to the premium associated with holding a physical commodity, rather than the associated derivative product or contract, as part of a futures contract: