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Impact of Japanese Yen Investment in the United States

Paper Type: Free Essay Subject: Finance
Wordcount: 2566 words Published: 8th Feb 2020

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This thesis talks about the impact Japanese Yen has when borrowed and exchanged into US Dollars to be invested in United States to generate positive returns in carry trade strategy. The literature has shown that this strategy is very rewarding, as it takes the advantage of interest rate differential between currencies. It is argued that the profitability of carry trade result from the failure of uncovered interest rate parity although this may be necessary but not a sufficient condition for the profitability of carry trade. In the literature it is documented that currencies with high interest rate tend to appreciate against low interest rate currency, as a result of the failure of uncovered interest rate parity. This will result in double gain for carry traders, one of them being interest rate differential and the other is foreign exchange rate gains.

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I would examine the validity of this conclusion by conducting carry trade portfolio using the currencies of Japan against the United States. I will also show that the data I used from the IMF are consistent with the literature, as it shows a positive return when a high interest rate country is used. The data also shows the impact of the exchange rate on the profitability of carry trade. 


Carry trade is strategy that is conducted by major financial institution and private investors. The strategy takes the advantage of interest rate differential between currencies. The operation is carried out by borrowing a low interest currency (called the funding currency), converting it into the high interest currency (called the target currency), that bring a higher yield, and at the end of the investment period converting the target currency back into the funding currency to repay the loan. The trader stands to make a profit of the difference between interest rate as long as the exchange rate does not change. The traders use this trade because the gain can become very large when interest payable on funding currency that has been converted into the target currency, which has been invested to increase the potential return on the investment. The moto of the carry trade is to “buy low and sell high” 1. The main objective of this trade is to take the full advantage of the interest rate differentials between the two currencies.

Carry traders often takes the advantage of uncovered interest rate parity (UIP), this is when the interest rate of Japan and the United State is equal to the exchange rate of Japan and the United States. When UIP holds then the average profit is equal to zero, this is because the interest rate gained is offset by exchange rate “any return from the interest rate differential needs to be in excess of any adverse exchange rate movements in the carry trade currency pair”2. Therefore; it is vital for carry traders that UIP does not hold to receive positive returns.

Profitability of Carry Trade

The interest rate can vary significantly across countries due to their different policy and the existence of macroeconomic imbalances. A country like USA that has higher growth tend to have high interest rate and stronger currencies. For us to examine how a positive carry trade occurs, we need to borrow money from a country that has a low interest rate and an example of that is Japan. A positive carry trade is one in which an investor borrows money in countries where the interest rates are low (Japan), and invest it in a country where interest rates are high (USA). The traders do this, as the gain is very large when leverage taken into consideration.

Carry trader assume that foreign exchange rates move in an arbitrary way. Therefore; the demand for foreign currency does not only depend upon returns but also on the risk. The main objective is to find out which one of the two currencies are profitable from carry trade by using both currency pairs and portfolio. In order to determine which of these currency yield higher rate of return if an individual were to pursue with carry trade. We need two pieces of information, the first is the interest rate offered by Yen (¥) deposits and Dollar ($) deposits, also how the yen and dollar values will change over a year. The second is the foreign exchange rate.

From the IMF data that I collected on excel we can see that at the beginning of 2008, the interest on Dollar deposits were 3.94 percent while on Yen it was 0.50 and the carry trader were making profit of around 3.44 percent. However; the interest rate on Dollar deposit started declining and reaching 0.16 percent in December due to financial crisis. This eliminated the interest rate differential between dollars and yen. The return on Japanese Yen in December 2008 was positive at 0.0636 percent. The very low US interest rate coupled with a dramatic rise in yen’s exchange rate made funding in dollars more attractive, as a result the investor changed from funding in yen to funding in US dollars, reversing the carry trade. However, normally carry traders invest money for the whole year or 6months, and from data we can see that the return on dollar deposits was still profitable when Japanese Yen was used in carry trade.

 Risk in the Carry Trade

One of the major risk carry traders face is the uncertainty of the exchange rate. If a trader involved in yen carry trade against the US dollars and if dollar were to depreciate in value relative to yen, then the trader will run the risk of losing money. A small depreciation in dollar will result in huge losses, this is because the transaction is generally done with lot of leverage. This is a huge let down to carry traders, from our data we can see that from September 2008 up until September 2012 the Yen appreciated and the exchange dropped from 104.30 per dollar to 77.57 yen per dollar. The yen appreciated against the dollar by 26 percent which made it harder to carry traders to make profit using yen.


In constructing my carry trade returns, I used the data from the IMF on the world’s major currencies Japanese yen (¥) and United States dollars ($). All spot and forward exchange rate are dollars denominated and are all from the data that I collected from the IMF website. The beginning of the sample is from January 2008, and the end of the sample is December 2016. This gives us a total observation of 96 month. The interest rates are dollar currency interest rate from the IMF data. We have used the expected rate of yen depreciation against dollar to determine the rate of return buy borrowing yen, converting it into dollar and investing. The formulas I used to calculate the expected rate of Yen depreciation against dollar is:



Whereas the F denotes the forward exchange rate of ¥ over $ and S denotes the spot exchange rate of ¥ over $.

To calculate the rate of return differences between Yen and Dollar deposits we use:



R¥ denotes the interest rate earned on ¥ deposits and R$ denotes the interest rate earned on $. The equation 1 and equation 1.2 are taken from International Economics (Ninth Edition).

When we compute the data that we derived from the IMF into equation 1 and 1.2 we would see from January 2008 up to November 2016 the results change in a very unpredictable manner. From beginning of the year January 2008 till the end of the year December 2008 the result on the rate of return difference between yen and dollar deposits changed drastically. From the table 1.3 we can see that at the beginning of the year2008 the difference was -3.42 percent which means that dollar deposits were giving higher yield. This result changed in December 2008, for the first time in more than a decade. The return on yen deposits were 0.06 percent which means that yen deposits yield higher return. From the table 1.3 we can see that this was partially due to appreciation in yen against dollar and partially lower interest rate on dollar deposits.

Table 1.3


United States

Exchange Rates, Domestic Currency per U.S. Dollar, End of Period, Rate

Financial, Interest Rates, Money Market, Percent per annum

Exchange Rates, Domestic Currency per U.S. Dollar, End of Period, Rate

Financial, Interest Rates, Money Market, Percent per annum

Expected Rate of Yen Depreciation Against Dollar

Rate of Return Difference Between Yen and Dollar Deposits

Jan 2008







Feb 2008







Mar 2008







Apr 2008







May 2008







Jun 2008







Jul 2008







Aug 2008







Sep 2008







Oct 2008







Nov 2008







Dec 2008







From October 2012 the yen started to deprecate against dollar and the interest rate on yen deposits and dollar deposits were almost the same. In October 2012 the exchange rate was 79.64 yen per dollar and it increased to116.80 yen per dollar by December 2012, while the interest rate on yen deposits also dropped from 0.9 percent in October 2012 to -0.04 percent in December 2012. The Federal Reserve also dropped the interest rate on dollar deposits from 0.16 percent to 0.09 percent in a period 1 year and 8 months. The federal reserve started to increase the interest rate from 0.09 percent in November 2014 up until December 2016 to 0.54 percent.


Looking at my findings, it can be concluded that using Japanese currency in conventional carry trade can be very profitable. Although there was a significant drop on the interest rate on dollar deposit from 2008 up until 2016, the dollar still yields higher return. Despite the appreciation of yen against dollar, the result showed that dollar was still profitable. The carry traders benefitted significantly by using yen in the past 2 decades.


  1. https://www.investopedia.com/articles/investing/081415/look-buy-low-sell-high-strategy.asp
  2. https://www.forextraders.com/forex-education/forex-strategy/the-carry-trade-and-its-risks/


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