Question & Answer
Q.What is a “Contract for Difference? A. A CFD is a form of investment known as a derivative which means an investor does not actually acquire a shareholding in a company. It is a form of spread-betting involving share prices.
University College Cork economics lecturer Séamus Coffey told the Anglo trial that the difference between shares and derivatives (like CFDs) was similar to the difference between having a share in the ownership on a horse and placing a bet on it.
Q. How do CFDs work?
A. An investor takes a “long” position if they believe a share price will increase in value in the future and a “short” if they believe it will fall.
In the first instance, when someone takes a “long position”, the seller of the CFD will pay to the buyer the difference between the share’s current value and its value at the future contract point.
However, if the share price falls over the period, the buyer will also have to fund the extra difference to the seller.
The converse works when a buyer adopts a “short” position.
Q. Why are CFDs popular? A. Although they do not grant investors voting rights in a listed company, CFDs allow them to gain economic exposure to one for a fraction of the cost of buying shares. The potential rewards if the share price goes in the anticipated director can be a multiple of the original investment. CFDs are also not liable for stamp duty, unlike shares. A further advantage is that the buyer of CFDs has no legal obligations to disclose their holding.
Q. Is there any negative aspect to CFD’s?
A. The most an investor can lose when buying shares is 100% of the original investment (in a situation where the share prices falls to zero). With CFD’s, an investor can lose many times the original investment.
In the current trial, prosecution barrister, Paul O’Higgins has described CFDs as “an extraordinary form of gambling”.
One of the world’s most successful investors, Warren Buffet, has described CFDs as weapons of mass destruction in terms of how they can distort share prices.
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