In the forex market, all trades must be settled in two business days. Traders who want to extend their positions without having to settle them must close their positions before 5pm Eastern Standard Time on the settlement day and re-open them the next trading the day. This pushes out the settlement by another two trading days. This strategy, called a rollover, is created through a swap agreement and it comes with a cost or gain to the trader, depending on prevailing interest rates.

The forex market works with currency pairs and is quoted in terms of the quoted currency compared to a base currency. The investor borrows money to purchase another currency, and interest is paid on the borrowed currency and earned on the purchased currency, the net effect of which is rollover interest.

In order to calculate the rollover interest, we need the short-term interest rates on both currencies, the current exchange rate of the currency pair and the quantity of the currency pair purchased. For example, assume that an investor owns 10,000 CAD/USD. The current exchange rate is 0.9155, the short-term interest rate on the Canadian dollar (the base currency) is 4.25% and the short-term interest rate on the U.S. dollar (the quoted currency) is 3.5%. In this case, the rollover interest is $22.44 [{10,000 x (4.25% - 3.5%)}/(365 x 0.9155)].

The number of units purchased is used because this is the number of units owned. The short-term interest rates are used because these are the interest rates on the currencies used within the currency pair. The investor in our example owns Canadian dollars, so he or she earns 4.25%, but must pay the borrowed U.S. dollar rate of 3.5%. The product of the difference in the numerator of the equation is divided by the product of the exchange rate and 365 because this puts our numerator into a daily figure. If, on the other hand, the short-term interest rate on the base currency is below the short-term interest rate on the borrowed currency, the rollover interest rate would be a negative number, causing a reduction in the value of the investor's account. Rollover interest can be avoided by taking a closed position on a currency pair.

To learn more, see Getting Started In Forex and Floating And Fixed Exchange Rates.

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