Yen Carry Trade to Dollar Carry Trade - A Perspective

Yen Carry Trade to Dollar Carry Trade
- A Perspective
(Project of International Financial Management)

By

Asokendu Samanta (RB 09035)

Centre: Powai, Mumbai
December 11, 2009

Yen Carry Trade to Dollar Carry Trade – A Perspective 1

Yen Carry Trade to Dollar Carry Trade
- A Perspective
(Project of International Financial Management)

Asokendu Samanta (RB09035)
PGCBM 15, XLRI, Center: Powai, Mumbai, Email: asokendu@hotmail.com
December 11, 2009

Abstract: Until middle of 2007, yen carry trade was one of the lucrative options to the traders. Not only
American dollar (USD) was high in terms of Japanese yen (JPY) during that time (June 18, 2007, 1 USD
= 123.87 JPY) (see Fig 1), but significant differences of interest rates between US treasury and borrowing
rate of Japan prompted traders to borrow Japanese currency with a relatively low interest rate and to use
the funds to purchase a different currency (i.e. USD) yielding higher interest rate in order to make a
significant amount of profit depending on the amount of leverage used. However, afterwards constant
appreciation of JPY in terms of USD (December 4, 2009, 1 USD = 87.8 JYP) and reduction of US deposit
interest rate has changed the scenario completely. As USD is depreciated in terms of other major
currencies (Euro, Great Britain Pound etc.) in 2009 and deposit interest rate in some country (i.e
Australia) is still higher than the borrowing rate of USA, traders now are encouraged in going for dollar
carry trade instead of yen carry trade. This aspect is described at length in this report with the help of an
excel based carry trade software named ‘samcarry’ (see appendix), which is developed by the author.
Though major world currencies (Australian dollar, Euro, Japanese yen, Great Britain pound, American
dollar) are used to make a comparison to understand which currency is beneficial for carry trade, Indian
currency, rupees (INR) is also considered for this purpose.

Key Words: Carry trade, Hedging, Interest rate, Risk appetite

Fig 1. Yen vs USD from 1999 to 2009 [source: http://finance.yahoo.com/]

Asokendu Samanta (SID RB09035, SMS ID 104118), PGCBM 15, XLRI, Center: Powai, Mumbai


Contents
Abstract 1
Contents 2

Chapter 1 Introduction 3-5

Chapter 2 Yen carry trade 6-8

Chapter 3 Dollar carry trade 9-12

Chapter 4 Possibility of Pound carry trade 13-15

Chapter 5 Conclusions 16

References 17
Abbreviation 17
Appendix 18-20



Chapter
ONE

INTRODUCTION

Introduction

A strategy in which an investor borrows a certain currency with a relatively low interest rate
and uses the funds to purchase a different currency yielding a higher interest rate is called
currency carry trade. A trader using this strategy attempts to capture the difference between
the interest rates, which can often be substantial, depending on the amount of leverage used.
However, a trader may incur huge loss if the exchange rate changes substantially and unfavorably during
the carry trade period when he has not hedged the funds.

An example will clarify the issue. If a trader borrows 1000,000 yen from a bank of Japan at an interest
rate of 0.5%, exchanges these currency to 10000 USD (let us assume 1 USD = 100 Yen) and deposits it in
a US federal Bank at an interest rate of 5.5%. At the end of one year, trader will get an amount 10550
USD (Principle amount 10000 USD + interest 550 USD) from federal bank. Let us assume that tax
required to be paid on the matured amount in federal bank is negligible. Now he has to pay back 1005000
yen which is equivalent to 10050 USD (if the exchange rate remains same) in Japanese bank from where
he took the loan. So he will make a profit of 500 USD (10550 USD matured value from Federal bank -
10050 USD Loan Pay back in Japanese bank). However, if the exchange rate changes in between and let
us assume Yen gets appreciated by 10% (now 1 USD = 90 Yen), he has to exchange 1005000/90 = 11167
USD to pay back 1005000 Yen loan in Japan. As a result, in that case trader will incur a loss of 617 USD
(10550 USD matured value from Federal bank – 11167 USD Loan pay back in Japanese bank).



Gain in the Carry Trade

Many professional traders use this trade because the gains can become very large when leverage is taken
into consideration.

Risk in the Carry Trade

The big risk in a carry trade is the uncertainty of exchange rates. If a trader involved in yen carry trade
against US dollar and if the dollar was to fall in value relative to the Japanese yen, then the trader would
run the risk of losing money. Also, these transactions are generally done with a lot of leverage, so a small
movement in exchange rates can result in huge losses unless the position is hedged appropriately.

Analysts did concede carry trades could reverse any time. That happened in the late 1990s during the
Asian crisis when dollar fell against the yen from a peak of 147.63 yen in August 1998 to a low of 111.53
yen by October of the same year. As soon as the storm passed, investors resumed selling the yen.

Yen, Dollar, Pound Carry Trades

In the present report, detailed discussions are made on yen carry trade (Chapter 2), dollar carry trade
(Chapter 3) and pound carry trade (Chapter 4) and their prospects separately. For this purpose, software
named ‘samcarry’ [Name is given after the title of the author] is developed to calculate the profit/ loss
for each carry trade. Carry trade can be calculated by the software between major currencies (Australian
dollar, Euro, Japanese yen, Great Britain pound, US dollar) along with Indian rupees. The software is
discussed in Appendix.

The present borrowing and depositing interest rates (Table 1.1) are collected from the website of a
particular bank of the various countries. Kindly note that these interest rates vary from bank to bank,
depends on amount and period of transaction, type of loan/deposit etc.. The present exchange rates
between currencies are also tabulated in Table 1.2 collecting from website http://www.bloomberg.com
and http://www.xe which will be required in calculating carry trades.

Table 1.1 Interest rate in different countries

Interest rate Australia Germany India Japan UK USA

Currency AUD1 EUR3 INR2 JPY4 GBP5 USD6
Depositing rate 6.5 0.25 6.00 0.172 2.0 1.5
Borrowing rate 13.9 1.75 12.00 2.0 3.7 3.7

1. ANZ Bank Australia (http://www.anz.com/aus)
2. State bank of India (http://www.statebankofindia.com)
3. European Central Bank (http://www.ecb.int)
4. Bank of Japan (http://www.boj.or.jp)
5. Bank of Scotland (http://www.bankofscotland.co.uk)
6. Bank of America (http://www.bankofamerica.com)



Table 1.2 Currency exchange rates* [as on 2 December 2009, 20:00 IST]

AUD EUR INR JPY GBP USD

AUD 1.6266 0.0234 0.0124 1.8004 1.0815

EUR 0.6148 0.01431 0.0076 1.1069 0.6649

INR 42.7342 69.5622 0.5287 76.9297 46.3410

JPY 80.8791 131.5549 1.8838 145.6139 87.4700

GBP 0.5554 0.9034 0.0130 0.0069 0.6007

USD 0.9246 1.504 0.0216 0.0114 1.6647

*
Source: http://www.bloomberg.com and http://www.xe.com



Chapter
TWO

YEN CARRY TRADE

Introduction

G oing back to the history, we can find out that the first modern yen carry trade occurred in the
late 1980s. Many traders borrowed yen to “invest” in the much-higher yielding currencies
that were participants of the ERM (European Monetary System) mechanism. This pressure
on the yen was further compounded by the huge investments in the real estate market in
U.S. at that time by Japanese investors. When the Nikkei and the Japanese real estate market started a
long decline in 1990, many Japanese investors were forced to repatriate their capital from overseas – thus
marking the beginning of the end of the first modern yen carry trade.

According to Henry [2006] (See Ref 5), yen continued to rise nearly 20% in 1990. It rose another 6% in
1991 and then declined slightly in the first few months of 1992. The first warning for the ultimate end of
the yen carry trade came in September 1992, when Great Britain was forced to exit the ERM mechanism
(it proceeded to fall from US$2 to US$1.40 in the next three months). While the yen initially held on (and
even declined), this was not to be – as Sweden followed with its own devaluation in November 1992 –
followed by Spain, Portugal and Ireland. By the end of 1992, Western Europe was severely weakened (as
many countries that had chosen to stay within the ERM had to raise their interest rates severely in order to
keep up with the rise in German interest rates following its reunification). Speculative outflows started



occurring in the beginning of 1993, and eventually turned into a torrent by the summer. The first modern
yen carry trade was now over, and the next yen carry trade would not occur until the summer of 1995.
From the beginning of 1993 when the yen (100) traded at US$0.80, the yen would eventually end up 50%
higher at US$1.20 by the summer of 1995.

The second great yen carry trade began in the summer of 1995 and it did not end until October 1998 –
when the yen ended its decline by rising 15% in a week!

The latest yen carry trade occurs during 2005-2007. According to Henry [2006], at its peak in late 2005,
the money flowing into foreign bond funds exceeded 5 trillion yen over the trailing 12-month period,
equivalent to about 1 percent of GDP. There are also some indications that foreign investors borrowed
yen to fund positions in higher-yielding currencies, but this evidence is more mixed and the magnitude of
this form of the carry trade is less certain. Data from the Bank for International Settlements show that
Japanese banks increased their net outward yen-denominated lending from $19 billion in 2004 to $87
billion in 2005. Japanese financial institutions probably also provided yen funding through derivatives
transactions with offshore counterparties, and Japanese banks have “increased investing in alternative
financial products, such as structured bonds, securitized products, hedge funds,” according to the Bank of
Japan.

Once the latest yen carry trade is over in the middle of 2007, yen continued to rise against USD till date
except a slight decline during April – August 2008 and January - April 2009, which is evident from Fig.
2.1. From Fig. 2.1 it can also be observed that from the beginning of 2007 to the end of 2009, yen rose a
whipping 34%!, This huge appreciation of yen against USD in addition to the decline interest rate in
USA, indicate that possibility of yen carry trade is remote now.

Fig 2.1 Japanese Yen vs. USD from July 2007 to December 2009 [Source: http://www.advfn.com/]



5

4 JPY

3

2

1

0
AUD INR EUR GBP USD
-1

-2

-3

Fig 2.2 Profit/loss (%) of yen carry trade in various currencies with present exchange and interest rate

Fig 2.2 shows the present scenario of percentage profit and loss if a trader wishes to do yen carry trade
using various currencies (AUD, INR, EUR, GBP, USD). The chart is prepared calculating the yen carry
trade using present software ‘samcarry’. It is assumed that exchange rate will remain constant after one
year (which may not be the case always) and tax required to pay in overseas country (depositing country)
is negligible. It that case, profit /loss is simply the difference between the interest rates of the overseas
country (where the fund is deposited) and Japan (from where fund is borrowed). As the dollar depositing
rate is reduced (present rate is 1.5%, See Table 1.1) and again it is higher than the borrowing rate (present
rate is 2%, see Table 1.1) of Japan, trader will incur 0.5% loss at the end of a year due to yen carry trade.
Which means yen carry trade (to dollar) is not profitable in the present scenario. However, it depends on
the appreciation/depreciation of the foreign currencies and whether the funds are hedged or unhedged.

It is interesting to notice from Fig. 2.2 that when yen carry trade using big currencies like, EURO, GBP,
USD is not profitable, carry trade using AUD, INR gives a good amount of profit (4-4.5%), as depositing
interest rate in Australia and India is more (6 – 6.5%, see Table 1.1). However, again this will depend on
the volatility of the exchange rate. Research has showed that volatility is the main enemy of the carry
trade.



Chapter
THREE

DOLLAR CARRY TRADE

Introduction

D ue to the appreciation of yen and depreciation of US dollar with respect to other foreign
currencies (see Fig 3.1 and 3.2) recently, a new trend is emerging, which is dollar carry
trade. According to Gertrude Chavez- Dreyfuss [2009] of Reuters, ‘Carry trades in the U.S.
dollar are barely six months old but the volume could surpass those seen during the peak of
yen carry transactions more than two years ago’. With low interest rate in US, easy and readily available
funds, investors have started borrowing huge sums of money in dollars to purchase higher-yielding assets
overseas in carry trades to achieve better returns.

Analysts are forecasting that this dollar carry trade may last at least three to four years and volume will be
bigger than the volume of yen carry trade happened during 2004-2007. Increased carry trade in the dollar
would likely result in further declines in the dollar, which has fallen 7 percent so far this year against a
major currency basket, weighed down by increasing risk appetite and low interest rates. From Fig 3.1 and
Fig 3.2 it is observed that from March 2009 to December 2009, dollar has fallen nearly 17.81% against
Pound and 17.5% against Euro. These figures are computed below.



0.73  0.60
With respect to Pound (from Fig 3.1),  100  17.81 % decline
0.73
0.80  0.66
With respect to Euro (from Fig 3.2),  100  17.50 % decline
0.80

Gertrude Chavez- Dreyfuss [2009], informs that Pi Economics, Stamford, Connecticut, suggested the
dollar carry trade might have reached $250 billion to $550 billion in the first half of 2009. At the height of
the yen carry trade, transactions were said to have hit $1 trillion, accumulated from 2004-2007.

Fig 3.1 GBP vs USD from in 2009 [source: http://finance.yahoo.com/]

Fig 3.2 EURO vs USD in 2009 [source: http://finance.yahoo.com/]

Federal Reserve has provided a blueprint of its policy intentions on low interest rates, which should help
keep volatility low. This indicates that U.S. carry trades are expected to keep growing. Japan's carry trade
thrived for years not just because of low rates, but because of low volatility.

Even Federal Reserve hike rates, it's almost impossible to see the U.S. returning back to 5 or 5.5 percent
fed funds rate where they are competitive with the rest of the world. This interest-rate differential would



be the ultimate long-term factor that will sustain the dollar carry trade in the same way the yen carry lived
for 12 years.

The general assumption is that the dollar carry trade gained momentum in the third quarter of this year as
risk appetite rose and the cost of benchmark three-month interbank dollar funds fell below those of the
yen.

4

3 USD

2

1

0
AUD INR EUR JPY GBP
-1

-2

-3

-4

Fig 3.3 Profit/loss (%) of Dollar carry trade in various currencies with present exchange and interest rate

Fig. 3.3 shows the percentage profit/loss for dollar carry trades when done using other major currencies
and using Indian currency, Rupees. This is calculated using software ‘samcarry’. It is observed that
though, dollar is declined against major currencies Pound, Euro and Yen, carry trade is not profitable
using these currencies as it is showing negative profit in Fig 3.3. This is mainly because, borrowing
interest of US is considered 3.7% (Table 1.1) in the present calculation, which is higher than the deposit
interest rate of UK (2%), Germany (0.25%) and Japan (0.172%) (See Table 1.1). These interest rates are
taken from the website of a particular bank of the respective countries and may vary from bank to bank
and depend on depositing period, type of deposits etc. A trader has to know the exact rate according to his
plan. However the rate mentioned in Table 1.1 will definitely give an idea and demonstrate a comparative
study between currencies.

It is also observed from Fig 3.3 that Australian dollar gives a maximum profit of 2.8% (difference of
interest rate = 6.5 – 3.7 = 2.8), followed by Indian currency, Rupees 2.3%. As the exchange rate volatility
of Indian currency is high, a trader has to carry a great amount of risk in doing carry trade from USD to
INR in an unhedged condition. Fig 3.4 is encouraging for such type of trading where it is observed that
INR is appreciated against USD from March 2009 (1USD = 52 INR) to December 2009 (1 USD = 46
INR), by nearly 11.5%.



Fig 3.4 Indian Rupees vs USD in 2009 [source: http://finance.yahoo.com/]

In the era of dollar carry trade, it is interesting to observe whether Pound can be a funding currency for
carry trade. It is discussed in the next chapter.



Chapter
FOUR

POSSIBILITY OF
POUND CARRY TRADE

Introduction

I n this chapter, possibility of pound carry trade is discussed. Though it is observed that pound is
appreciated against US dollar recently (Fig. 3.1), it is observed that pound is heavily depreciated
against Australian dollar (Fig. 4.1, March 2009 to December 2009, nearly 18%). pound is also
getting depreciated against yen recently (Fig 4.2, August to December 2009, 10%) and against
Indian Rupees (Fig. 4.3, September to December, 3%). These prompted traders to think the possibility of
pound carry trade. Katie Martin [2009], in World Street Journal mentioned that ‘While hard data on
how investors use the so-called carry-trade are hard to come by, the pound is currently trading lower
against the "Aussie" and the "Kiwi" than it has in more than a decade, as they have soared to 2009 highs
against the U.S. dollar’. He has also quoted that analysts have found a new funding currency in the pound.
However it is too early to say whether pound can be used a carry trade. An analysis with data will give a
better understanding.



Fig 4.1 Australian dollar vs GBP in 2009 [source: http://finance.yahoo.com/]

Fig 4.2 Japanese yen vs GBP in 2009 [source: http://finance.yahoo.com/]

Fig 4.3 Indian Rupees vs GBP in 2009 [source: http://finance.yahoo.com/]



Fig. 4.4 shows the percentage profit/loss after pound carry trade. This data is generated using present
software ‘samcarry’ and using the interest rate of Table 1.1 and currency exchange rate of Table 1.2. It is
also assumed that exchange rate is not changed during the carry trade period and tax is negligible. It is
observed that while Australian dollar gives 2.8% profit, Indian currency is giving 2.3% profit. Other
currencies (Euro, Japanese Yen, USD) is not profitable for pound carry trade. These results are similar to
dollar carry trade results (Fig. 3.3) as borrowing rate of UK and USA are same (3.7%) as per Table 1.2.
As a result once needs to observe market before predicting whether pound carry trade is profitable or not.

4

3 GBP

2

1

0
AUD INR EUR JPY USD
-1

-2

-3

-4

Fig 4.4 Profit/loss (%) of Pound carry trade in various currencies with present exchange and interest rate



Chapter
FIVE

CONCLUSIONS

Summary

C hanges of scenario from early yen carry trade to recent dollar carry trades are discussed in
the present report with the help of a recently developed excel based software ‘samcarry’.
The software is easy to use and user friendly. Possibility of pound carry trade is also
discussed with the help of practical data. Tabulated current interest rates of various
countries (Table 1.1) and exchange rate between major currencies (Table 1.2) are very helpful for this
purpose. A few important aspects which are observed during the analysis are given below.

i) Software named ‘samcarry’ is developed in order to calculate profit/loss quickly for a carry
trade. User has the facility in calculating carry trade between five major currencies (Australian
dollar, Euro, Japanese Yen, Great Britain Pound, US dollar) along with Indian Rupees.
ii) Yen carry trade, which was predominant for the last few decades, is over for the time being
against GBP, Euro and USD. However, against AUD and INR it is still profitable as depositing
interest rate in Australia (6.5%) and India (6%) is still very high compared to borrowing interest
rate of Japan (2%).
iii) Dollar carry trade is barely six month old. However it is estimated that trade may have already
reached $250 billion to $550 billion in the first half of 2009. At the height of the yen carry trade,
transactions were said to have hit $1 trillion, accumulated from 2004-2007.
iv) Dollar carry trade against Indian Rupees (INR) is profitable (2.3%). However it is risky due to
the high volatility of exchange rate unless traders hedged the funds.
v) A possibility of Pound carry trade may occur, particularly using Australian dollar as pound is
depreciating heavily against AUS (18% in this year). However it is too early to predict such
forecast.
vi) Rupees carry trade is not possible as borrowing interest rate of India is very high (12%)
compared to depositing rate of other countries (1.5 - 6.5%).



References
[1] Class Note on International Financial Management, by Prof. H. K. Pradhan, XLRI, Jamshedpur,
2009.
[2] International Financial Management, Tata McGraw-Hill Publishing Company Limited, 2nd Edition,
New Delhi, 2008.
[3] Gertrude Chavez- Dreyfuss, ‘U.S. dollar carry trade may exceed yen peaks’, Reuters, (2009).
[http://www.forbes.com]
[4] Katie Martin, ‘A New 'Carry-Trade' currency? U.K. Pound emerges as possibility’, World Street
Journal, (2009). [http://online.wsj.com]
[5] Henry To, ‘The Yen carry trade revisited’ (2006). [http://www.marketthoughts.com]
[6] Official website of Bloomberg, http://www.bloomberg.com
[7] Official website of Yahoo Finance, http://finance.yahoo.com
[8] Official website of XE, http://www.xe.com
[9] Official website of ADVFN, http://www.advfn.com
[10] ANZ Bank Australia (http://www.anz.com/aus)
[11] State bank of India (http://www.statebankofindia.com)
[12] European Central Bank (http://www.ecb.int)
[13] Bank of Japan (http://www.boj.or.jp)
[14] Bank of Scotland (http://www.bankofscotland.co.uk)
[15] Bank of America (http://www.bankofamerica.com)

Abbreviation

AUD Australian Dollar
ERM European Monetary System
EUR Euro
GBP Great Briton Pound
INR Indian Rupees
JYP Japanese Yen
USD American Dollar



Appendix

Software ‘samcarry’
This software is developed by the author and in this section a description of the present excel based
software ‘samcarry’ is discussed. Fig. A1 is a snapshot of the software. The software has the capability
to calculate the profit/loss at the end of the carry trade period in terms of five major world currencies
(Australian Dollar, Euro, Japanese Yen, Great Briton Pound, and US Dollar) along with Indian Rupees.
As the exchange rate between currencies changes constantly and interest rates (both deposit and
borrowing) of a particular currency in a country are also market dependent, options are given in the
software so that users can put the latest figures. Users have the option in calculating tax on the interest
before calculating final profit/loss. An example will clarify the entire software.

Fig. A1. Snapshot of the ‘samcarry’ software



Example: Let us assume a trader wanted to borrow 10,000 US dollar from US at a rate of 3.7%, exchange
it to Australian dollar at an exchange rate of 1.0815 (AUD/USD=1.0815) and invest in Australia at a rate
of 6.5% for 1 year. If the exchange rate remains same after one year (USD/AUD=1/1.0815=0.9246) and
he does not have to pay any tax on the interest amount, how much he can earn profit/loss at the end of one
year carry trade?

Solution: It is mentioned in the ‘instruction’ of the software that users have to give input only in the
‘Green’ color cell. The software has three parts.

Part 1: Borrowing part, where users have to give input related to currency borrowing (i.e. amount, interest
rate etc).

Part 2: Depositing part, where users have to give input related to currency depositing (exchange rate,
deposit period, interest rate etc).

Part 3: Calculating part, where users have to give input related to reverse currency exchange rate, tax rate
etc.

Summary and conclusions do not need inputs. Summary indicates the total transaction and at the end in
conclusion, profit/loss are indicated in currency as well as percentage basis.

For this present example, user has to select the following options which is mentioned in ‘Blue’ color.:

Part 1: Borrowing
From which country would you like to borrow currency? USA (from drop down menus)
What is the amount you would like to borrow? 10000
What is the borrowing rate of that currency in that country? 3.70

Part 2: Depositing
In which country would you like to deposit the currency? Australia
What is the currency exchange rate? 1.0815
What is the period of deposit? (YY/MM/DD) 1, 0, 0 (first digit indicates year, second month and third
days)
What is the deposit interest rate for that period? 6.5

Part 3: Calculating
What is the speculated exchange rate at the end of the period? 0.9246
What is the tax rate you have to pay on interest in depositing country? 0

If the funds are hedged, user needs to put the hedged rate in Part 3. Having received these inputs,
software will give the following summary. And at the end profit/loss are calculated in conclusions. If it is
a profit, ‘Hooray! you are in profit’ message will appear and if it is loss, ‘Sorry, you are in loss’
message will appear. In both the cases, profit/loss will be calculated in % basis and will be visible at the
end of this line. In the present case, it is a profit of 302.31 AUD, which is 2.80% of the investment
amount of 10,000 USD.



Summary

Conclusions

This software has the facility to calculate carry trade between any two currencies of the six currencies
(AUD, EUR, INR, JPY, GBP, USD) mentioned earlier.

The End


Yen Carry Trade to Dollar Carry Trade - A Perspective

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