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Nick1984

Interest Rate Parity

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I've never traded forex in my life but have always been interested in it. Anyone who trades regularly may be able to answer this. Does interest rate parity exist in the real world? Eg. Is it really worth your while borrowing Yen and coverting it to USD,EUR,AUD etc to gain from higher local interest rates then converting back to Yen to repay your loan?

 

From all I've learnt, IRP states that because the interest rate in the Yen is much lower the currency will appreciate relative to which ever currency you convert to so that when you convert back the gain is neutralised and your still overexposing yourself to translation risk.

 

On a side note, how often do you guys find yourselves spotting arbitrage opportunities i.e like triangular arbitrage?

 

Cheers :)

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Good question, but I'm not the right guy to answer that. Maybe Buk or Texxas might be better experienced in giving this type of strategies. I'm just a straight arrow GBPUSD trader, not looking at crosses and correlations, etc. They are interesting but these strategies require a higher degree of accuracy and of course computer-aided software to calculate the differences. Just my perspective though.

 

I recently read an article on the Yen and Japenese economy blaming hedge funds and other institutions for using large amounts of CARRY TRADE, basically borrowing/buying the target currency of that country in order to profit higher interest rate of that country. Sounds valid but it's causing some unwanted volatility.

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Is it really worth your while borrowing Yen and coverting it to USD,EUR,AUD etc to gain from higher local interest rates then converting back to Yen to repay your loan?

 

 

If you’re talking bout actually “trading†the physical instruments, which I guess you are? then all you're seeking is value & prospective cross compounding, yeah?

 

As you say, the carry exists because of the interest rate differential between the trading nations. Money shifts around seeking high yield. The buck & Sterling currently benefit from a + 5.2% bias on the differential, whilst the EU attracts + 3.25% yield over the Asian currency.

 

If you look at a Daily chart based on those trading partners you’ll see the positive flow in positioning yourself short Yen (Long Dollars, Sterling & Euro)

 

Unless the rate differential gets squeezed (Yen rates increase and/or the others deflate), then nothing will really unseat the carry advantage, & traders will proportionally leg into yield advantage.

 

Sure, every once in a while outside influences spook the fast money or shorter frame speculators, but if the generic fundamentals hold good, then the long range players will merely soak up those pullbacks to buy more contra Yen positions.

 

As a trader, your prime objective is to seek value & compound profits. By exploiting the carry, spread across the array of cross instruments, you're utilizing positive bias.

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I've never traded forex in my life but have always been interested in it. Anyone who trades regularly may be able to answer this. Does interest rate parity exist in the real world? Eg. Is it really worth your while borrowing Yen and coverting it to USD,EUR,AUD etc to gain from higher local interest rates then converting back to Yen to repay your loan?

 

From all I've learnt, IRP states that because the interest rate in the Yen is much lower the currency will appreciate relative to which ever currency you convert to so that when you convert back the gain is neutralised and your still overexposing yourself to translation risk.

 

On a side note, how often do you guys find yourselves spotting arbitrage opportunities i.e like triangular arbitrage?

 

Cheers :)

 

With regards to Triangular arbitrage it is very doubtful that as an assumed retail trader even if you spotted an opportunity, that you could execute across the 3 currencies quickly enough & cheaply enough without slippage, to benefit.

 

Unless the rate differential gets squeezed (Yen rates increase and/or the others deflate), then nothing will really unseat the carry advantage, & traders will proportionally leg into yield advantage.

 

A number of scenarios exist for this;

*BoJ raising rates

*US,NZ,AUS,UK etc lowering rates

*Yield spreads opening

*Flight to safety

*Maturities

*Depreciating asset classes [for the more aggressive]

*Rising Yen [on speculative buying pressure]

 

jog on

d998

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If you're asking whether there's a no-brainer way to make money then the answer is no. If you buy USD/JPY then you'll receive interest every night. That's the "carry trade". The risk of course is that USD/JPY falls and you close your position for a loss.

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