Mrs watanabe and the japanese yen carry trade mini case

Multinational Business Finance

Fifteenth Edition

Chapter 6 Mini Case

Mrs. Watanabe and the Japanese Yen Carry Trade

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1

Mrs. Watanabe and the Japanese Yen Carry Trade (1 of 2)

At more than

(some $16,800bn), these savings are considered the world’s biggest pool of investable wealth. Most of it is stashed in ordinary Japanese bank accounts; a surprisingly large amount is kept at home in cash, in tansu savings, named for the traditional wooden cupboards in which people store their possessions. But from the early 2000s, the housewives—often referred to collectively as “Mrs. Watanabe”, a common Japanese surname — began to hunt for higher returns.

—“Shopping, Cooking, Cleaning… Playing The Yen Carry Trade,” Financial Times, February 21, 2009.

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Mrs. Watanabe and the Japanese Yen Carry Trade (2 of 2)

Over the past 20 years, Japanese yen interest rates have remained extremely low by global standards.

This presents opportunity for uncovered interest arbitrage (U I A).

Borrow money where it is cheap and invest it in a different currency market with higher interest returns.

The only real trick is to time the market correctly so that when the currency in the high-yield market is converted back to the original currency, the exchange rate has either stayed the same or moved in favor of the speculator.

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Yen Availability (1 of 3)

Japan has consistently demonstrated one of the world’s highest savings rates for decades. This means that an enormous pool of funds has accumulated in the hands of private savers, savers who are traditionally very conservative.

Those funds, whether stuffed in the mattress or placed in savings accounts, earn little in return.

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Yen Availability (2 of 3)

A second factor facilitating the yen carry trade is the sheer size and sophistication of the Japanese financial sector.

The Japanese banking sector has been continuously in search of new and diverse investments with which to balance the often despondent domestic economy. It has therefore sought out foreign investors and foreign borrowers who are attractive customers.

Multinational companies have found ready access to yen-denominated debt for years.

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Yen Availability (3 of 3)

A third expeditor of the yen carry trade is the value of the Japanese yen itself.

The yen has long been considered the most international of Asian currencies, and is widely traded. It has, however, been exceedingly volatile over time.

The key has been in the relatively long trends in value change of the yen against other major currencies like the U.S. dollar, or as in the following example, the Australian dollar.

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Australian Dollar/Japanese Yen Exchange Rate (1 of 2)

Exhibit A illustrates the movement of the Japanese yen/Australian dollar exchange rate over a 13-year period.

This spot rate movement and long-running periodic trends have offered a number of extended periods in which interest arbitrage was highly profitable.

The two periods of Aussie dollar appreciation are clear. During those periods, an investor who was short yen and long Aussie dollars (and enjoying relatively higher Aussie dollar interest) could and did enjoy substantial returns.

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Exhibit A the Trending J P Y and A U D Spot Rate

For long description, see slide 17: Appendix 1

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Australian Dollar/Japanese Yen Exchange Rate (2 of 2)

Consider the one-year speculation detailed in Exhibit B.

An investor looking at the exchange rate in January 2009 (Exhibit A) would see a yen that had reached a recent historical “low”-a strong position against the Aussie dollar.

Betting that the yen would likely bounce, weakening once

again against the Aussie dollar, she could borrow

million at 1.00% interest per annum for one year. She

could then exchange the

million yen for Australian

dollars at

and then deposit the proceeds for one

year at the Australian interest rate of 4.50% per annum.

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9

Exhibit B the Aussie-Yen Carry Trade

For long description, see slide 18: Appendix 2

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10

Post 2009 Financial Crisis (1 of 3)

The global financial crisis of 2008–2009 has left a marketplace in which the U.S. Federal Reserve and the European Central Bank have pursued easy money policies. Both central banks, in an effort to maintain high levels of liquidity and to support fragile commercial banking systems, have kept interest rates at near-zero levels.

Now global investors who see opportunities for profit in an anemic global economy are using those same low-cost funds in the U.S. and Europe to fund uncovered interest arbitrage activities. But what is making this “emerging market carry trade” so unique is not the interest rates, but the fact that investors are shorting two of the world’s core currencies: the dollar and the euro.

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Post 2009 Financial Crisis (2 of 3)

Consider the strategy outlined in Exhibit C.

An investor borrows E U R 20 million at an incredibly low rate.

The E U R 20 million are then exchanged for Indian rupees (I N R), the current spot rate being I N R 60.4672 = E U R 1.00. The resulting I N R 1,209,344,000 are put into an interest-bearing deposit with any of a number of Indian banks attempting to attract capital.

The rate of interest offered, 2.50%, is not particularly high, but is greater than that available in the dollar, euro, or even yen markets.

But the critical component of the strategy is not to earn the higher rupee interest, it is the expectations of the investor regarding the direction of the I N R per E U R exchange rate.

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Exhibit C the Euro-Rupee Carry Trade

For long description, see slide 19: Appendix 3

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Post 2009 Financial Crisis (3 of 3)

Carry trade activity is often described in the global press as if it is easy or riskless profit. It is not.

As in the case of the euro-rupee just described, the combination of interest rates and exchange rates is subject to a volatile global marketplace, which does indeed have a lot of moving parts.

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Mini-Case Questions

Why are interest rates so low in the traditional core markets of U S D and E U R?

What makes this “emerging market carry trade” so different from traditional forms of uncovered interest arbitrage?

Why are many investors shorting the dollar and the euro?

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Copyright

This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials.

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16

Appendix 1

Long Description for a graph plots Japanese yen per Australian dollar measured monthly from January 2000 to July 2013.

The graph indicates three trends in the monthly yen to dollar rate, as described in the following list. All values are estimated.

The rate generally increased from around 68 in January 2000 to near 105 in January 2007. This change indicates that the Japanese yen depreciated steadily against the Australian dollar from 2000 to 2007.

The rate remained above 100 until 2008. It then fell to around 60 in January 2009.

During the period from 2009 to 2012, the rate once again increased, ending near 102 by January 2013. After the dramatic appreciation in 2008, the yen depreciated steadily again versus the Australian dollar.

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Appendix 2

Long Description for a diagram represents the Aussie yen carry trade.

The Aussie yen carry trade occurs over 360 days. The following list provides the steps in the process.

Start. The investor borrows 50,000,000 yen at 1.00% interest. The funds borrowed at 1.000% per annum bill need to be repaid in one year. The principal and interest on the borrowed funds is 50,000,000 times 1.01 = 50,500,000.00.

The investor converts the yen amount into Australian dollars at a rate of J P Y 60.91 yen = A U D 1.00. J P Y 50,000,000 yen divided by 60.91 = A U D 820,883.

The Australian dollars are then invested at the higher Australian dollar interest rate of 4.50% per annum for one year. A U D 820,883 times 1.045 = A U D 857,823.

The result, principal, and the interest of A U D 857,823 are then converted back to Japanese yen at the current spot rate. With luck, talent, or both, the result is profitable. The spot rate is J P Y 83.19 = A U D 1.00. A U D 857,823 times 83.19 = J P Y 71,362,296.83.

End. The amount owed is J P Y 50,500,000.00. The amount earned is J P Y 71,362,296.83. The profit is J P Y 71,362,296.83 minus J P Y 50,500,000.00 = J P Y 20,862,296.83.

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Appendix 3

Long Description for a diagram represents the Euro rupee trade.

The Euro rupee trade occurs over a 180 day period. The following list provides the steps in the process.

Start. The investor borrows E U R 20,000,000 at 1.00% interest. The funds borrowed at 1.00% per annum bill need to be repaid in 180 days, principal and interest. 1.00% per annum is 1.005 for 180 days. E U R 20,000,000 times 1.005 = E U R 20,100,000.

The investor converts Euros to Indian rupees at I N R 67.40 = E U R 1.00.E U R 20,000,000 times 67.40 = I N R 1,348,000,000.

The Indian rupees are invested at 2.50% per annum, or 1.0125 for 180 days. I N R 1,348,000,000 times 1.0125 = I N R 1,364,850,000. The result, principle, and interest of I N R 1,364,850,000 are converted back to Euros at the spot rate in the market in 180 days of I N R 68.00 = E U R 1.00. I N R 1,364,850,000 divided by 68.00 = E U R 20,071,324.

End. The investor paid E U R 20,100,000. The investor earned E U R 20,071,324. The profit was minus E U R 20,100,000 plus E U R 20,071,324 = - E U R 28,676. Unfortunately, the small movement in the spot rate has eliminated the interest arbitrage profits.

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¥ 1,500,000bn

¥50

¥50

¥60.91A$,

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