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?


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.


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

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Mutual Funds & ETFs

    Top Three Transportation ETFs

    These three transportation funds attract the majority of sector volume.
  3. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  4. Investing Basics

    Tops Tips for Trading ETFs

    A look at two different trading strategies for ETFs - one for investors and the other for active traders.
  5. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  6. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  7. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  8. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  9. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  10. Mutual Funds & ETFs

    Top 4 Investment Grade Corporate Bonds ETFs

    Discover detailed analysis and information about some of the top exchange-traded funds (ETFs) that offer exposure to the investment-grade corporate bond market.
  1. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  2. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. 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 >>
  5. 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 >>
  6. 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 >>

You May Also Like

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!