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# 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

##  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 we return the loan the rate is 100
 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