Currency Carry Trade

PRESENTED BY:
GROUP NO. 8,
SECTION: C
(PGDM : 2010-2012)
 Index

Introduction to Currency Carry Trade

An illustrated example.

The dollar vis-a-vis The Yen

Risks in CCT & future inhibitions.

CCT: The Indian Scenario

 What is Currency Carry Trade?

It’s the practice in which an investor borrows

low yielding currencies and lends (invests in)
high yielding currencies.
(A strategy in which an investor sells a certain currency with a relatively
low interest rate and uses the funds to purchase a different currency
yielding a higher interest rate. A trader using this strategy attempts to
capture the difference between the rates, which can often be substantial,
depending upon the leverage used.)

Most Common Examples: Dollar & Yen carry Trades.

 Helping you understand better…

Let’s say,

A man borrows Rs. 100 from an Indian bank at 1% interest rate p.a for 1
year. Now after 1 year, he’d need to return Rs. 101 to the bank (Rs. 100
being the principal amount and Re. 1 being the interest payable).

Now, assume that the person converts the Rs. 100 into equivalent dollars
and invests that money in the American bond market. He buys a bond in
dollars worth Rs. 100 in Indian currency that yields him a 5% interest
rate p.a with the bond maturity period being 1 year.

After 1 year, the person would collect the maturity amount in dollars and
convert in back into rupees. If the value of the dollar v/s the rupee is
assumed to be same over the year, the person would have Rs. 105 with
him in total. Out of this, he’d return Rs. 101 to the bank and be left with a
surplus of Rs. 4 as his own profit.
Interest Rates in early 2008 (Central Banks)

 Japan 0%
 Switzerland 1%
 Sweden 2%
 Eurozone 2.25 %
 United States 4.5 %
 New Zealand 7.25 %
 Iceland 10.75 %

(The differential between the two countries interest rates can

be used to make money – That is essentially CCT!)
What facilitates Currency Carry Trade the most?

Carry trade in any currency mainly needs to fulfill

three basic criteria;

 A crippled bank system which would be ready to lend at even 0%

interest rate.

 A crippled currency that offers little risk of raising exchange rate.

 Plenty of avenues for investment.

 The Yen Carry Trade

In the mid 90’s, the Japanese economy still trying to

recover from its late 80’s recession offered the perfect
ground for the ‘Yen Carry Trade’

In 2007, USD 1 trillion was staked on yen carry trade.

Since mid 90’s, Bank of Japan has set Japanese interest

rates at very low level. This made it profitable to borrow
Japanese Yen to fund activities in other countries.
(These activities included sub-prime lending in the USA
and funding of emerging markets in the resource rich
BRIC nations)
 Continued…

This trade largely collapsed in 2008 in USA when the US

Federal Reserve dropped the Fed Funds Rate to a near
zero.

Investors across almost nations across the globe also lost

money in 2008 as the value of the Yen started soaring.

However, it’s still going strong with currencies like

Brazilian Real, Australian Dollar, Turkish Lira and other
high yielding currencies.
(for e.g., an investor may still borrow yen at less than
1% interest rate and invest in Australian Dollars which
have 4.5% return)
 The Dollar Carry Trade

Found its origin during the Nixon Government when

USD replaced Gold as the international reserve currency.

Has been back in fashion post 2008, with the US

economy being severely crippled and Fed Funds Rate
being at an approximate 0.25%.

“Short the dollar, long everything else” is the new

investment mantra.

Worked like a charm at the Wall Street. And will

continue to do so till Fed raises the cost of money.
 The Risks…beyond the obvious!

 Foreign exchange rates may change to the effect that investors may need
to pay back more expensive currency with less valuable one!
 (Example: The Krona Blood bath!)

 The cheap money may be utilized to fund risky projects in emerging

economies.

 Speculation can also cause prices to deviate from their intrinsic value if
speculators trade on misinformation. May lead to an economic bubble
and a subsequent burst.

 Money moves from low inflation countries to high inflation ones and
escalates it further.

 Analysts believe that such destabilizing effect on the economy may

trigger the next economic crisis.
 CCT- Implications for India

 Being an emerging economy, India is a hot destination for foreign currency.

(Indian bourses alone attracted around Rs 83,424 crore of net FII inflows in
2009 against net outflows of Rs 52,987 crore in 2008 and crossed 1 lakh crore
in 2010 till now. )

 While this money can be used to propel economic growth, with more dollars
being pumped into the market, it may also get difficult to control inflation.

 Many believe that real growth that can sustain market and prices can only be
homegrown. Not funded by borrowed money that would ultimately find an exit.

 Banking on a weakening dollar and exposing itself to long term leveraged risks
may put Indian corporate in trouble. A trade reversal may leave many of those
bankrupt!
 Thank You
For
Your Attention!