Official Power point presentation by Mr Neeraj Batra ,Chairman of infinity business school and one of India's leading investment bankers.The presentation explains the concept of yen carry forward trade.

1. The Yen Carry Forward Trade
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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2. o The Japanese market is Export driven. The Govt. The Yen Carry Forward Trade
keeps the yen USD rate in a narrow band to avoid
Unemployment and stimulate Domestic Spending.
The Worlds Second Largest Economy has had a
negative growth rate in the last three years and is
expected to grow at 1.40 % in 2010/11
o The Japanese have amongst the lowest interest
rates in the world. Long term Govt. debt is already at
180 % of GDP and expected to exceed 204 % of GDP
as The Japanese Govt Announced a USD 1 Tn Budget
for 2011 which will cause Public Debt to rise by USD
485 Bn to roughly $10.50 Tn
o Thus the Japanese Govt. has a biased position to
keep interest rates low- to fund its own debt, avoid
deflation and spur investment/domestic demand.
o On a positive side 90 % of this debt is held by
domestic Japanese Investors and Japan’s Cumulative
domestic savings exceed $ 15 Tn.
o The Bank of Japan intervenes aggressively to keep
the yen peak to protect its exporters.
Neeraj Batra GCMI Copyright INFINITY BUSINESS
SCHOOL

3. The Yen Carry Forward Trade
• However the Japanese population is ageing. In the
next 20 years, 33 % of its population will be over
65 years old. This may cause a problem for
funding Govt. Debt in the future.
• Japan has the second largest USD reserves of
approximately USD 1.05 Trillion and enjoys a large
current account surplus. Between 2001 and 2009
these reserves Grew from USD 350 Bn to 1 Tn.
• However during this period the JY remained weak
vs.the USD and moved from 104 to 120 (It
currently trades at 91.50 after the unwinding of
the Yen C/f Trade)
• Between 2004-7 Global hedge funds exploited this
situation They understood fully well that despite
low interest rates the exchange rate will be
managed by the Central bank of Japan and kept
weak against the USD.
Neeraj Batra GCMI Copyright INFINITY BUSINESS
SCHOOL

4. The Yen Carry Forward Trade
• This resulted in what is popularly now
known as the Yen Carry Forward Rate
• This assumed many forms. It resulted in
cross currency exposure (between the JY
and the relevant counter currency) and also
a cross asset exposure
• E.g. a Borrowing of JY and subsequent
investment in a US Treasury Bill creates a
USD/JY Exposure on maturity of the
Loan/Investment.
• Hedge Arbitraged and Borrowed in JY. Sold
the JY to convert into USD. Then Invested
the USD in Govt. bonds of New Zealand
which yielded 8 %pa
• More commonly hedge funds borrowed JY
,shorted it in spot markets to buy equities
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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5. The Yen Carry Forward Trade
• Logically if the interest rate on one
currency is lower than the interest
rate for another currency (for a
similar maturity) then the first
currency must necessarily trade at a
premium (i.e. be more expensive in
the forward market) to the second
currency in the Foreign exchange
markets such that there is no
arbitrage possible between the
currency and money markets e.g. if
interest rates in JY are at 1 % pa and
USD are at 3 % pa for One year then it
follows that the one year forward
JY/USD exchange rate must negate
this 2% % interest difference entirely.
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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6. • Lets test this hypothesis The Yen Carry Forward Trade
• A currency with a low interest rate
must quote against a currency with a
higher interest rate at such a premium
in the forward foreign exchange
markets such that the interest
differential is negated
• Unless this happens arbitrage would be
constantly possible (see example)
Money Market Forex Market
JPY 6 1.20% Spot Rate 85
Month
Rate
USD 6 3.60% 6 Month 83.998 WHY
Month rate ??
Rate
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7. • A Hedge Fund borrows 6 month JY 85 The Yen Carry Forward Trade
Mn for 6 months @ 1.20 % pa
• He then sells this JPY in the Spot Foreign
Exchange Markets to get USD 1 Mn
• He invests the USD 1 Mn at 3.60 % pa in
the US Treasury Bill markets
Now after 6 Months he owes the
Japanese Bank:
(85 Mn X 6/12 X .012 )+ (85 Mn)
JY 85,510,000
• His Investment in the US treasury will
yield as follows:
1 Mn x 6/12 x .036 + 1mn=
USD 1,018,000
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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8. • Thus unless the 6 month Futures Fx rate is
The Yen Carry Forward Trade
83.998 arbitrageurs would make risk free
returns i.e. the yen must quote at a
premium (more expensive) to the USD to
the exact extent of the interest rate
differential or 83.998 in the 6 month futures
market.
• Anything weaker say 87 , Hedge Funds will
do the following:
• If JY/USD quotes 6 month fwd 87 then HFs
would borrow JY at 1.20 % 87 mn (spot
rate), sell yen to get USD 1 mn
• Invest in 3.60 % T Bills and
• Simultaneously the HF Would buy JPY 6
month forward at 87 for an equivalent USD
of 1,018,000 (Why ?)
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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9. • After 6 months the HF would owe the The Yen Carry Forward Trade
Japanese Bank JPY 85,510,000
• It would receive USD 1,018,000 from the
US market
• It would have converted this USD
Amount already at the 6 month Fwd
contract and would get 88,566,000 JPY
(87 x 1,018,000)
• Thus the HF would make risk free
3,056,000 Mn JPY (88,566,000-
85,510,000)
• Thus the Fwd 6 month Fx rate of yen
must quote exactly at 83.998 i.e. the
premium = Int.rate differential on the
Spot day.
• The real JY/USD Spot Rate after 6 months
may however be higher or lower
Neeraj Batra GCMI Copyright INFINITY BUSINESS
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10. • Anything stronger say 83 , Hedge Funds will
The Yen Carry Forward Trade
do the following:
• HF will Borrow USD at 3.60 % 1mn (spot
rate), sell USD to get Yen 85 mn. Thus he
will owe the Bank 1,018,000 after 6 months
• Invest in 1.20 % JY Deposit and
simultaneously buy USD 6 month forward
worth 85,510,000 JY (Why ?) at 83 worth
1,030,240
• Thus he makes a profit of 12,240 USD per
USD 1 Mn borrowed as an arbitrage profit
without assuming any risk.
• Thus only at the exact exchange rate of
83.998 does arbitrage get prevented
Neeraj Batra GCMI Copyright INFINITY BUSINESS
SCHOOL

11. The Yen Carry Forward Trade
• However since the Japanese Govt. wanted to keep its
exports competitive it did not like the Yen to appreciate
• This resulted in HF taking a bet on the forward rate of the
USD/Yen maintaining a narrow band such that the fund could take
advantage of the interest rate differentials but keep an open
forward position on the exchange rate till maturity and resulted in
Trillions of Dollars of Yen Carry Forward Trade till 2008.
Neeraj Batra GCMI Copyright INFINITY BUSINESS
SCHOOL