Yen Carry Trade

by Manshu on March 28, 2007

in Articles

With the increase in globalization and ease with which investors can borrow money in one market and invest in another new forms of arbitrage are coming up every day.
The Yen Carry Trade is one such example of a form of arbitrage where investors are borrowing cheap yen and then investing it in US Treasury bills to generate a higher rate of return.
Following is an example of how this would work:
Suppose an investor borrows USD 900 worth of yen at 0.5% rate of interest from Tokyo and converts them into USD at an exchange rate of 120 yen per dollar. The investor adds his own 100 dollars and then buys US T-Bills which give a return of 4.5%. So on an investment of 1000 USD or 120,000 yen the investors get an interest of 45 dollars. On the amount that they have borrowed in yen they have to pay an interest of 4.5 dollars so effectively they stand to make $40.50 on $100 worth of their own money.  This is a really cool 40% return on their initial investment.
However this is not completely risk free because of exchange rate fluctuations. This is because the interest on the loan and the actual repayment has to be made in yen and not dollars, so if the exchange rate changes from 1 USD = 120 yen to 1 USD = 100 yen, at the end of the year the investor would get back 1040 dollars, but in yen terms they would amount to just 104,000. So while the investor at the beginning of the transaction started off with 120,000 yen at the end of it despite the interest ends up with a smaller amount.
This is what is known as Yen Carry Trade and the reason why this has become noticeable in the recent times is that the price of they Yen has moved up thereby making a few such transactions unprofitable which in turn have triggered a cycle wherein more and more people are selling off their dollar assets and buying back yen which in turn in again causing the price of the yen to go up and cause more unwinding of positions.

{ 1 comment… read it below or add one }

Biplab Das March 29, 2007 at 1:42 am

good article. It gives an insight into less travelled forex arbitrage, at least my me.

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