Derivative contracts: relevant contracts: contracts for differences: examples
Examples of contracts for differences (CFD)
A company has borrowed €10m for two years. It hedges the loan by entering into a euro/ sterling currency swap with a bank for the same amount and the same period. If the company does nothing to hedge the borrowing, it risks making a loss if the value of the €10m, measured in sterling terms, increases because it would then cost more to repay the loan. The purpose of the swap is to remove that risk of loss. It comes within the definition of a CFD.
A company buys a call option over the FTSE 100 index. If, at the exercise date, the FTSE 100 is above a specified level (the strike price), the company will exercise the option and receive a cash sum calculated by reference to the difference between the actual level of the FTSE 100 index and the strike price. This is a CFD - fluctuation in the level of the FTSE 100 index can potentially result in a profit for the company. (There is no possibility of property being delivered under the contract, so the provisions of CTA09/S580(2) mean that it will not be classed as an option for the purposes of Part 7 CTA09 - see CFM50340.)
Although companies will most frequently use a CFD as a hedge (as in example 1), a contract that is held speculatively (as in example 2), or as trading stock, will also fall within the definition.