Group 10

A trade where you borrow and pay interest in order to buy something else that has higher interest  The idea is to take advantage of the low interest on borrowing side  Channel this money to yield higher return  Finally pocket the net interest income  Carry trade occurs when a individual borrows in one currency and trades in another

Japanese bank have close to zero lending rates.  This condition is in place for years (as a result of stagnant economy).  This allows investor and speculator to borrow money at low interest rates.  Speculator leverage heavily and invest in bonds, equity markets, commodities, etc  The exposure of Yen Carry Trade in 2007 was between $80 billion – $160 billion

Suppose we take a loan of $900000 @ .25%  We add 100000 as our fund  The leverage ratio is 1:9  We invest this amount in 4 parts

Bonds - investing 300000 assuming returns @ 8%  Mutual funds – investing 200000 assuming returns @ 15%  Low risk stocks - investing 350000 assuming returns @ 25%  High risk stocks - investing 150000 assuming returns @ 35%

Total returns = 8% @ 300000 + 15% @200000 + 25% @ 350000 + 35% @ 150000 Profit = 24000 + 30000 + 87500 + 525000 Profit = 194000 Return on invested funds = 194000/1000000 = 19.4 % Interest returned on loan = .25 *900000 = 2250 Return on equity = 191750/100000 = 191.75 %

The carry trade is susceptible to Change in lending rates  Recently BOJ raised lending rate to 0.5%  Change in exchange rate hurt the carry trade

A change of 10% appreciation in Yen against Dollar  Results in 100% reduction in profit

Let yen vs dollar be 110 at the time we took loan of 900000

900000/110 = 8181.81$

 When
 100*

we return the loan the rate is 100

9000 = 900000  A 10% loss due to exchange rates on invested funds  Margins on equity come down from 191.75% to 83.2%

Yen carry trade fuels speculative buying  Currency movements results in deleveraging which causes volatility in exchange markets

 Due

to the current recession lending rate of American banks is close to zero  This has resulted in Dollar becoming the popular carry trade currency

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