What is Swap of Rollover Fee?

When you buy or sell a currency, a swap or rollover fee may be paid or received on a daily basis. This is simply the interest owed/paid to maintain your position, and the amount of which will depend on the relative interest rate yield of each currency. You are essentially using the currency you have sold to fund the currency you have bought.

To get a little technical, you now need to look at the relative yields of each countries interest rate to gauge an understanding on if you are going to receive or indeed pay interest on a daily basis. If you decided to buy one contract of the AUD/USD pair at 9800 US, this means you are borrowing US dollars to fund your AUD 100,000 position. This is a particularly good pair to use as an example given the large interest rate yield differential.

Let’s use benchmark interest rates as at November 2010 for each currency to get a general understanding if we are due to pay or receive interest. The overnight cash rate set by the Reserve Bank of Australia is currently 4.75%, therefore you would expect AUD 100,000 dollars to earn at least at least 4.75% PA. On the other hand you are borrowing US dollars, given the Federal Reserve are attempting to stimulate US economy interest rates are near zero, therefore, theoretically the cost of borrowing is a lot cheaper.

In essence, you are borrowing at rock bottom rates to fund a higher yielding asset – hence interest should be paid to you. So to ascertain if you are due to pay or receive interest or swap on a currency simply, compare the interest rates of each country and check if you are buying or selling the currency with a higher yielding interest rate. You will also need to take into account swap calculations are not as simply as two interest rate differentials, often funding costs can be greater than that of the underlying interest rate.

This article has been taken from Introduction to Foreign Exchange from GO Markets. For a free copy of the e-book, you can sign up here.