A term that many individual investors had not heard of until this week and now cannot get out of their heads is "carry trade".

The goal of this strategy is to borrow money at a low interest rate in one currency, convert the money into a different currency, and invest the borrowed money into a higher yielding bond.

This strategy has been implemented by currency traders for several years with the Japanese Yen (JPY).

For years, the interest rate in Japan was 0% and offered traders the ability to borrow in Yen and convert the money into another currency that offered higher rates such as the U.S. Dollars.

An example would be a trader borrowing Yen at 0.25% (the current interest rate set by the Bank of Japan) and reinvesting that money into a 10-year U.S. Treasury bond at 4.52%.

The numbers speak for themselves, and it is not difficult to figure out why this has been such a popular strategy with currency traders.

There have been a number of reports suggesting that traders will be looking to unwind their Yen carry trade positions. As the Yen rallies and the U.S. Dollar falls, the traders implementing the Yen carry trade could run into trouble with the real risk of losing money on the trade.

The unwinding of this trade would result in mass buying back of the Yen and selling of the other currencies. There are concerns that this action could result in a liquidity crunch worldwide.

To add fuel behind this unwinding threat, the U.S. Dollar, which has been in a downtrend since peaking in 2002, is expected to likely continue its slide lower. At the same time, the Japanese Yen just had one of its best weeks in a long time, rallying 3.7%.

From a technical viewpoint the Yen broke above an important resistance level that spurred on more buying to end the week. So if the unwinding of the Yen carry trade continues, how can the individual investor hedge their portfolio or better yet, profit from it?

japan.gif

Source: StockCharts.com

Rydex Investments offers the CurrencyShares exchange-traded funds (ETFs) for investors that do not have access to a currency trading account. If you believe like I do that the Yen has more room to move on the upside, the CurrencyShares Japanese Yen Trust (NYSE: FXY) is your ticket.

Over the last week, FXY has gained 3.7% as the S&P 500 fell over 4%. Of the other currencies that Rydex offers ETFs in, the Swiss Franc (CHF) is currently yielding the second lowest interest rate. This led to a 1.2% gain in the CurrencyShares Swiss Franc Trust (NYSE: FXF) during the last week.

fxf2.gif

Source: StockCharts.com

The debate between further unwinding of the Yen carry trade will go on for weeks, if not longer. If you would like to participate in the unwinding, the two best ETF options are FXY and FXF.

Even if the large unwinding does not take place, both ETFs should be able to perform well with the U.S. Dollar in a continued downtrend. Carry trade or not, these two ETFs are the best options for investors looking for a way into foreign currencies.

Related Articles
  1. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  2. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  5. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  6. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  7. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
  8. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
  9. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Turkey

    Learn about the iShares MSCI Turkey exchange-traded fund, which invests in a wide variety of companies' equities traded on Turkish exchanges.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Derivative

    A security with a price that is dependent upon or derived from ...
  3. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  4. Security

    A financial instrument that represents an ownership position ...
  5. Series 6

    A securities license entitling the holder to register as a limited ...
  6. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
RELATED FAQS
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!