Carry Trade Explained Thursday, July 19, 2007
Posted by ei-forum in Miscellaneous.trackback
What is all this talk about the “Carry Trade”? Everyone keeps on talking about it but what is it? What does it mean?
Well, it’s not as complicated as one could think. Basically, the concept revolves around a play on currency yields. It consists in borrowing a low-yielding currency and investing the amount in a currency that is offering a higher yield; the yield difference representing your gain (minus tax and commissions).
An example of this could be to borrow 1,000 Yen and convert them into USD and then use them to by a USD denominated bond. Assuming that the bond pay 5% and that the Japanese interest rate is at 0,35%; you would stand to make a profit of 4,65% (as long as the exchange rate stays the same). Furthermore, using a common leverage of 10:1, this would mean that you would stand to make a profit of 46,5%!
Easy money? Well, we should all know that potential returns are always related to the amount of risk you are taking on. If you decide to execute this kind of trade, then it means that you are makanig a bet on the exchange rate direction but please remember that depending on the amount of leverage you decide to use, gains AND losses can be very substantial.
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good simple analysis. It’s amazing how much leverage some take on such a position though. It’s not uncommon to see currency bets of 50 to 1 meaning if you have $1,000 you can play with 50,000 of currency. It doesn’t take much of a swing (2%) to knock out your entire capital balance and leave you with nothing. On the other hand – how much fun would it be to double that $1,000?
you can see how it gets addicting!
Hi Zach, thanks for your comment. Indeed, it is addictive … I know a lot of people (me too???) that have spent a lot of time looking at the bid/ask and running virtual portfolios with 1,000,000USD leveraged up to 100!!! But at the end of the day, poker is good fun too and there is no margin involved! We prefer to stick with value stock picks…