CFD – Contract for DifferenceA Contract for Difference or more commonly known as CFD is a popular financial derivative instrument used by a wide range of people for different purposes. Essentially, a CFD is a futures contract on a certain asset such as shares of a company, the price of a commodity or any other financial instrument. It allows the CFD buyer (or seller) to buy (or sell) the asset without directly owning it. The transaction is carried out with the help of a market maker provider who attempts to match the transaction, whether buy or sell, with the opposite transaction. However, as the CFD is a derivative of the real asset, the buyer or seller may not exist on the platform on which the transaction is made. In this case, the market maker provider will match the purchase or sale assuming the risk. For each transaction, the market maker will charge a small transaction fee. In addition to transaction fees, the market maker will operate all transactions based on the asset being traded. For example: Trader A buys 100,000 CFDs in company XYZ at $1.00 per share. The spread on XYZ at the given trade time is: BUY XYZ $0.99 c Sell XYZ $1.00 Because trader A is buying at the market rate, he is buying at the ask rate of $1.00 per CFDs. $1.00 x 100,000 CFDs = $100,000. The margin requirement on xyz company is 5%. Trader A is only required to invest $5,000 of capital and the market maker makes up the remaining $95,000. The market maker charges an interest rate normally linked to the OCR. In this case 3% (OCR) +2%. This is called the holding cost. Trader B made a trade for the sake of argument to sell 100,000 CFDs in Company XYZ. The same margin rules apply to trader B however he is credited with interest at the rate of ...... middle of paper ...... being borrowed on the real market, it is possible to hedge with much less capital. An example of using CFDs to hedge against currencies: Company A is based in New Zealand and expects to receive 100,000 pounds from a UK based company in 2 months for design and construction of certain equipment. Company A has fixed costs in NZD and, at the time of signing the contract, calculated the cost in NZD. Company A wants to protect itself against fluctuations in the pound sterling. To do this, they buy 100,000 British pounds in the CFD market. In this case, the currency has a margin of 1%, so the capital it needs to complete the transaction is 1,000 British pounds or 1,960 NZD (at an exchange rate of 1.96). The cost to Company A to maintain this hedge is 100,000 (sterling) x 1.96 (exchange rate). ) = $196,000nzd @ 5.5% interest (OCR + 2.5% margin) - $10,780 per year $29.54c per day + any margin call requirement.