Module 2

Financial markets

This module contains details of the different types of CFD that we offer
and an explanation of the underlying financial markets that influence
their prices. The module also explains the difference between cash and
forwards markets and looks at pricing mechanisms, such as how the fair
value of a future is calculated.

Financial markets

CFDs are extremely versatile: you can trade just about any financial market as a CFD and, as a result, IG Markets
offers you the opportunity to speculate on literally thousands of different financial products from all around the
world. Although you gain an incredible diversity of markets, its also kept fairly simple: all these markets can be
traded on one account and the manner in which they work falls into three general methods.
The first of these methods is the way in which we treat share trades, as detailed
in Module 1. That is, we charge a percentage commission per trade; there is
no minimum deal size, but there is a minimum commission (also known as a
minimum ticket); positions are subject to adjustments based on dividends
and daily interest (funding). These transactions are undated: positions have no
expiry date and remain open until closed by you (or closed out in the case of
insufficient margin being provided to maintain the position).
The second of these methods applies to spot or cash markets, including FX,
cash Stock Indices and Spot Gold and Silver. For these markets, the minimum
transaction size is one contract (or one mini-contract if available); we do not
charge commission, but instead quote an all-in dealing spread; positions are
subject to adjustments based on daily funding and any dividends
(if applicable). These transactions are also undated.

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The third and final method is for Expiry Transactions,

which includes all our Forward contracts and our Options
contracts. For these products, we quote a dealing spread
rather than charging commission, but there are no daily
funding adjustments; positions expire at a specified date in
the future against an underlying financial market (there is
also a specified last dealing time for these positions, after
which the transaction will be held to expiry. Positions may, of
course, be closed anytime before the last dealing time).
Many people find CFDs to be more accessible and userfriendly for the average retail investor than the underlying
financial instruments against which the markets are settled,
such as exchange-traded futures. Even so, it is worth taking
a look at and gaining an understanding of these original
markets.

Stock indices
An index value is created by compiling a number of stock prices into one total value, and expressing the value
against a base value from a specific date, thus allowing investors to easily follow the performance of certain
groups of stocks (usually a certain number of leading stocks from a given stock market).
All our cash Stock Indices can be nominated to settle against specific cash
stock index markets (which can be referred to as the related expiry market).
For example, lets say that you have a position in the Singapore Blue Chip,
long two contracts. Your position is undated: the position remains open, being
adjusted daily for interest and dividends. To close your position, you can deal at
any time at our bid/offer quote by selling two contracts. Alternatively, you can
ring one of our dealers and request that your position be allowed to expire at
the end of the trading day. If we acquiesce your position becomes an expiry
transaction: it will expire at a specified point against a specific market, namely,
the closing price of the Singapore Free Index.
Its worth noting that we are not always able to agree to an expiry request. We
will try our best to accommodate any such request, but we are unlikely to be
able to if the position is either larger than ten contracts or if the request is made
less than two hours before the close of the market against which you would like
your position to expire.

The following table shows our more popular Stock Indices

and the related expiry markets against which they can be
requested to settle:
Name

DJIA

US SPX 500

S&P 500

US Tech100

Nasdaq 100

FTSE 100
Singapore Blue Chip
Australia 200

FTSE 100
Singapore Free Index
S&P/ASX 200

Germany 30

DAX

EU Stocks 50

DJ Euro STOXX 50

Hong Kong HS34

Japan 225

Related expiry market

Wall Street

Hang Seng
Nikkei 225

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Complete lists of the Stock Index CFDs that our investment service covers and their related expiry markets can be found in the Contract Details
section of www.igmarkets.com.sg.

More details on this subject can also be obtained from our PureDeal platform by selecting Get Info from the dropdown menu next to a markets name.

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Stock indices
So if you have a position in cash Wall Street, you can request that your trade
be settled against the official closing price of the Dow Jones Industrial Average
(DJIA). The DJIA is, like all cash stock index prices, not a tradeable instrument in
its own right: you cannot buy or sell directly the DJIA itself (although it is possible
to buy funds that track the performance of the index).
This is because it is simply a benchmark (produced as a composite of 30 leading stocks on the New York Stock Exchange), designed to indicate how the US
stock market is performing. Markets that can be traded, such as Dow Jones
futures and S&P futures, will react much faster to economic news than the
equivalent cash index.
Underlying cash indices tend to lag behind slightly, particularly when trading is
beginning for the day, as they are simply a reflection of the prices of the components that make them up if half of the components of the Dow Jones have
not traded ten minutes after the opening of the trading day, the index is unlikely
to reflect the true current situation.
The futures will give a far better picture indication in such a scenario, and
for this reason, we use a variety of sources in order to price our Stock Indices.
Consequently, the price of our FTSE 100 or Wall Street markets, for example, may
often be at a different level to the cash FTSE 100 or DJIA.

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Shares

Shares are a popular form of investment that most people are familiar with and consequently are one of the
most popular types of CFD that we offer. We offer shares from most of the major territories, including Singapore,
Australia, the US, UK, Canada, Japan* and most of Europe.

Datafeeds
The share prices on PureDeal are actual exchange prices. When you open
your account, we automatically grant you free access to delayed shares data,
allowing you to view data from several exchanges from around the world
without incurring any exchange fees.
It is very easy to subscribe to live prices via the Datafeeds section of the My
Account area in PureDeal, but this does incur a fee from any exchange to
which you subscribe. We will refund this cost if you are sufficiently active in your
dealing, however (this is described in more detail in the live prices section
below).

Delayed shares data and

Snapshot Dealing
When you are viewing prices, if you see a circular red icon
(containing a numeral) next to the time in the Update
column, it means that the price is delayed by the number of
minutes shown in the red icon.

*Japanese stocks are not available to trade online.

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For example, of the prices shown in this screenshot, Telefonica, Vodafone and Air France are all delayed by 15 minutes. It is still possible to deal,
even if you have not subscribed to live data, by using our Snapshot Dealing function.

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If you open a Ticket from delayed data and enter a deal size, the Sell and
Buy buttons do not become active (that is, highlighted red and blue so that
you can place a deal) in the same way as for a Ticket that has been opened
from live data.
In order to make the Sell and Buy buttons become active, you first need to
click on the green Start Live Data button.

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Now the buttons become active, the Start Live Data button becomes grey, and
the prices you see are real time (you must first enter a deal size before clicking
on Start Live Data. The size does not affect the price you see, however).
As the name suggests, with Snapshot Dealing the prices become live only
temporarily, long enough to allow you place a deal. How long you have
remaining before the data reverts to being delayed is indicated graphically by
a number of empty blocks below the Sell button.

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As time progresses, the blocks slowly fill. You only have live prices so long as
there is an empty block remaining. Whilst the prices are live, you can click on
Sell or Buy and place a deal.
If you do not deal before all the blocks are filled, the Ticket slips back into the
delayed state, with inactive Sell and Buy buttons, a red delayed icon and a
green Start Live Data button.

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Selecting live share prices

In order to view live share data, you need to launch the My Account window
and then select Data Feeds.
From the form, you can select which exchange you would like to receive live
prices from.
As a default, no exchange is set to live data.
Exchanges are set to delayed data where available: in the screenshot, for
example, LSE and Euronext are set to 15 minute delays and ASX is set to a 20
minute delay.
A red cross next to an exchange means that delayed prices and Snapshot
Dealing are not available. For these exchanges, therefore, prices are switched
off as a default.
In order to select an exchange for live data, you simply need to click in the
row for the pertinent exchange in the L1 column (L1 refers to the level 1 data
that is provided). Displayed in this column is the cost per month that live data
incurs.

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Exchanges charge in their local currency; we provide a rough equivalent in

the base currency of your account of the total charges you have selected,
although this is just a guide. Once you click the green Request Feeds button
your account is immediately billed for the total fees you have selected, and you
will now be able to view live prices for the exchanges for which you have been
billed (obviously, your request will be rejected if you do not have sufficient funds
available on your account to cover the total fee).

exchange in the month in question. The number of deals

you need to place is listed in the Active column. As you can
see, for many exchanges you only need to place one deal
per month in order to qualify for a rebate (provided you
are a non-professional user; the number may be greater for
professional users).

We will rebate you the data fee for an exchange at the end of the month,
provided you have placed a certain number of deals on shares from that

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Please be aware that fees are levied per calendar month, and are not
charged pro-rata according to when you sign up. For example, if you select live
data with only two days remaining in the month, you will still be charged the
full monthly fee, but receive data for just the two days.
For example, lets say that you are interested in dealing Singapore shares that
trade on the Singapore Exchange (SGX). Going to the DataFeeds control
panel, you see that next to Shares SGX (Singapore) there is the red delayed
icon, displaying 20. This means that you are currently set up to see Singapore
share prices that are delayed by 20 minutes. You are able to deal using the
Snapshot Dealing function, but decide that you would like to receive live
prices.
You therefore click in the L1 column, clicking next to the SGD 3.00, which
is the indicated monthly fee for SGX data. You then click Request Feeds.
SGD 3.00 is debited from your account and you can now view live Singapore
price data.
In the Active column it displays 1 for SGX, meaning that you only need to
place one deal (on an SGX share) by the end of the calendar month in order
to be considered active and therefore receive a rebate for the fee.

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Module 2: Financial markets

FX

The FX (Forex) market is the biggest market in the world with a daily turnover approaching $2000 billion. There
is no formal exchange for currency transactions; transactions are instead conducted Over-The-Counter (OTC) and
rates at any one time are defined by the Interbank rate (which comprises the FX bid/offers that large international
banks are quoting to their counterparties).
Our FX prices offer a simple and easy way to speculate on how one currency
will perform against another.

Spot FX
The spot market is the market for immediate currency trades. In the underlying
market, transactions are ostensibly made for delivery two business days after
the transaction date. In practice, the vast majority of individuals trading FX are
speculating, with no plans to take delivery of physical currency. If a speculator
holds a position beyond the close of the current business day, the open position
is netted off and then re-established for the next day at a new rate. This new
rate is calculated as the closing level of the old position plus or minus an
adjustment which is determined by the difference in interest rates between the
two pertinent currencies (this process involving closing and re-opening with an
adjustment is known as a Tomorrow Next Day or Tom Next procedure).

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Spot FX is simpler with us: there is no expiry or rollover. Instead

your position remains open until you close it. The difference
in the exchange rate that occurs whilst your position is open
determines how much you make or lose. Whilst your position
is open, adjustments are made on a daily basis to replicate
the effect of Tom Next calculations.

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Example: buying Spot GBP/USD

You think that the British pound is likely to strengthen against the US dollar and accordingly opt to take a long
position.
Our quote for GBP/USD is 1.5736/1.5739 and you buy one contract at 1.5739.
One contract is the equivalent of 100,000, which gives you an exposure of
US$10 for every pip movement in the rate (our price means an exchange rate
of 1.5739 dollars for every pound; in other words, one pip is 0.0001 dollar per
pound and for your 100,000 position this means that one pip is 0.0001$/ x
100,000 = $10). There is no commission to pay, as all our charges for FX are
contained in the spread.

Module 2: Financial markets

While your position is open, your account is adjusted

each day to reflect the overnight effect of the interest rate
differential between the pound and the dollar (in other
words, replicating the charge or credit of a Tom Next
procedure, as dictated by the Interbank Market, plus a small
charge of no more than 0.0008%).
You are long sterling and short US dollars (with US interest
rates being higher than UK at the time), so that you will be
charged interest for being long of the lower-rate currency.

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Lets say the total daily interest adjustment is 0.36 points. As your position is
US$10 for every pip, this works out as 0.36 x US$10 = US$3.60. This amount is
credited to your account.
Two days later GBP/USD is trading at 1.5874/1.5877 and you decide to take your
profit. You sell one contract at 1.5874 to close your position.

Your 100,000 contract meant US$10 per pip, giving you a

profit of 135 x US$10 = US$1350.
To calculate the overall profit, you also have to include the
accumulated daily interest adjustments.

Your profit on the trade is calculated as follows:

Closing level:

1.5874

Opening level:

1.5739

Difference:

135 pips

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Commodities, Energies and Metals

As well as Shares, FX and Stock Indices, we also offer CFDs on an extensive variety of products, including grains,
metals, oils, softs and livestock. The prices of these products can sometimes move wildly because of supply and
demand issues. For example, a glut of tropical storms during 2005 caused severe fluctuations in the price of Orange
Juice, owing to a reduced crop.
Nearly all our contracts on Commodities, Energies and Metals are Forward
contracts (transactions that expire at some set point in the future) and settle
basis exchange-traded futures contracts (Spot Gold and Silver are notable
exceptions, which are undated contracts and which, therefore, do not expire).
Many of these Forward contracts expire in the month before the named
contract month: for example December London Cocoa expires in November.
This is so that we do not end up with an obligation to buy or sell the physical
underlying for any positions that we have taken in order to hedge our exposure.
This is explained further in the section on futures below.

An explanation of futures
Our Forward contracts settle at some future date and are analogous in many
ways to underlying futures contracts, albeit with certain differences. The most
important similarity between the two is the pricing: futures trade at a different
price to the cash price.

Module 2: Financial markets

The definition of a future is that it is an agreement to buy or

sell a standard quantity of a specified asset on a fixed future
date at a price agreed today.
Futures that trade on an exchange are traded in
standard quantities known as contracts. Our contracts for
Commodities, Energies and Metals replicate these contract
sizes. You can only trade in whole contracts when dealing on
such exchanges; with our products, however, you can deal
in whatever size you like, provided it is at least one contract.
In other words, you do not have to deal in whole multiples
of contracts and can in fact deal in fractions of contracts
(when trading online).

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We also offer mini-contracts on many of these markets. One mini-contract offers

a smaller exposure than one standard contract. For example, one contract
of Cotton offers an exposure of US$5 for every point movement of our quote,
whereas one mini-contract of Cotton is half the size at US$2.50 per point
movement.
The reason futures came about in the first place was to allow producers of
agricultural products to offset risk.
For example, a corn farmer will have to invest money in order to grow and
harvest his crop, paying for such necessities as seeds, labour, fertiliser, etc. Whilst
the farmer is outlaying these costs, there is a risk that the price of corn may drop
to a level insufficient to cover the outlay at the time that the corn is sold.
Because futures allow a price to be agreed today for a sale at some time in
the future, the farmer would be able to utilise futures in order to achieve a sale
price for the crop and thereby remove any exposure to variations in the price of
corn. With the knowledge of what the sale proceeds will be, the farmer can go
ahead and make a sensible business plan.
On the other end of the futures transaction may well be a speculator
someone who thinks the price of corn is going to go up, and is willing to take on
the risk that the farmer is seeking to lay off.

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The delivery of futures contracts occurs on a fixed date

that is known as the delivery day; for most commodities this
means that on this date, money is exchanged for goods,
and the goods are physically delivered. Many financial
futures, such as stock index futures, are cash settled, which
means that no asset is actually transferred and instead the
difference between the price of the futures and the price of
the underlying asset is settled in cash.
All CFD contracts are cash settled. We hedge extensively
in the underlying futures markets in order to cover our
exposure on the trades that we accept, but obviously do not
want to take delivery of platinum or oil, for example. For this
reason, trades on Forward markets that settle against futures
contracts that have physical delivery are always settled well
in advance of the delivery date. This means that a trade on,
say, December Silver might expire in November rather than in
December.
An essential feature to understand about futures is how they
are priced.

Module 2: Financial markets

Commodities, Energies and Metals

If we compared the cash price (also known as the spot price) of gold in early July with the futures price of gold for
delivery in October, we might note the prices below:
Spot Gold

$950 per troy ounce

October Gold

$957 per troy ounce

As you can see, the February Gold price is higher in this example than the cash
price. What is the reason behind this? It is an easy, and largely false, assumption
to make that the reason underpinning this price difference is that the price of
gold is due to rise.
In reality the price of a future is affected by a number of factors that take into
account the cost that would be involved in holding the physical to the expiry
date (the so-called cost of carry) as well as market sentiment.
The fair value is the theoretical price that a future should be trading at given
the cost of carry and working from the cash price (it therefore does not take
into account such factors as sentiment, squeezes in the market, etc).
If we continue to use gold as an example, consider the circumstances of a
jeweller who has been commissioned to design and construct a collection of
gold jewellery for a customers birthday in four months time. He knows he will
require 100 oz of gold but only in four months hence in order to make the
jewellery. Unless he wants to take a risk with the price of gold (and potentially

Module 2: Financial markets

end up paying more to buy the gold at the time than he has
accepted for the commission), he can guarantee the price
of the raw material in one of two ways. He can either buy
the physical gold now, or buy gold futures for delivery in four
months.
If he chooses the former, he will have to outlay the cost
straight away. Doing so will require financing, and this will
incur costs: either the jeweller will have to take out a loan
and pay interest on that sum over the period, or he will have
to withdraw the funds from his savings account, thereby
sacrificing any interest that he would receive on the credit
balance over the period. Additional costs will be incurred in
the form of insurance and storage costs for the gold until he
sells the jewellery.
Choosing to buy the futures contract will mean that the gold
will only have to be paid for in four months time, thereby
requiring no interest, storage or insurance costs. As nothing
in life is free, the futures price will take into account these
costs (if it is fairly priced).

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So for gold (and other commodities):

Fair value = current cash price + cost of carry
In an efficient market, the real futures price should trade at the same level as
the theoretical fair value of the future. If the futures price diverges too far from
the fair value, arbitrageurs will trade the future in the opposite direction to which
it has diverged (i.e. selling if the value has risen above the fair value and vice
versa), whilst also taking an offsetting trade in the cash market. Because of this
arbitrage, the value of futures will always eventually return to the fair value.
The fair value for stock indices is similar to the one described above, except
the carrying charges are different. There are no storage costs to consider in the
cost of carry and the physical pays out dividends, whereas the future does not.
Therefore the cost of carry is interest costs less any dividends.

So lets look at an example of calculating the fair value of

December Wall Street.
Lets say that it is July and the level of Wall Street is 11500
with interest rates at 2.0% per annum and the dividend yield
being 2.4% per annum. If there are 135 days until the expiry
of the Forward contract, the fair value would be calculated
as follows:
Fair value

= 11,500 + 11,500 x (2.0% - 2.4%) x 135/360

= 11,500 + 11,500 x -0.4% x 0.375

= 11,500 - 17.25
= 11, 4827.25

For stock indices:

Fair value = current cash price + interest costs over the period - dividends
over the period
Interest costs = cash price x annual interest rate x days to expiry/365
(The divisor is usually 365 for UK and Singapore products and 360 most other
countries, including the US and Australia)

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Commodities, Energies and Metals

Factors such as sentiment (i.e. a bias by traders of the future towards buying
or selling) may cause the price of a future to diverge from the fair value in the
short-term, thereby making the price either cheap or expensive, in theoretical
comparison to the fair value. When this happens in the actual markets,
traders looking to exploit this effective mispricing will either sell the futures (if
theoretically expensive) or buy them when cheap, whilst simultaneously placing
an offsetting trade in the cash market.

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This activity is known as arbitrage and, if done correctly, is a

way of making a risk-free profit. It is an important activity in
the financial markets as the action of arbitrage causes the
future price to move back towards its fair value and thereby
sustains the crucial relationship between the cash and the
futures markets (its worth noting that most ordinary investors
do not have access to the low transactional costs required
in order to make arbitrage economically feasible and that
even professional traders who do enjoy low costs will not
undertake arbitrage unless the futures move sufficiently far
from the fair value in order to compensate for exchange
fees, market spreads, etc.).

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Summary
By now you should:
Be more familiar with the different financial products that we offer and the
underlying markets by which they are influenced
Understand the concept of futures
Know how fair value is calculated
Be aware of arbitrage

Our products are geared and can result in losses that exceed your initial
deposit. Please consider whether they are suitable for you and refer to the
risk disclosure statement at www.igmarkets.com.sg to ensure that you fully
understand the risks and costs involved.
IG Markets (ACRA No. 53059621X) holds a capital markets services licence
for dealing in securities, trading in futures contracts and leveraged foreign
exchange. IG Markets is also licensed to trade commodity CFDs by
The International Enterprise Singapore. IG Markets does not operate a
securities or futures market.

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Notes

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Notes

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Notes

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TradeSense Singapore, June 2009, 3rd Edition

IG Markets
30 Raffles Place
#24-04 Chevron House
Singapore 048622

(65) 6390 5118

www.tradesense.com.sg