What the rising cost of the carry trade means for your investments

Now that central banks in Europe and Japan are raising interest rates, the days of easy money trades look to be over. What do the rising costs of carry mean for asset prices? And, asks Richard Benson of Specialty Finance Group, what does it mean for your investment strategy?

Up until just recently the only bargains in the carry trade were achieved by borrowing at lower interest rates in the euro and yen. This can be risky, though, because of the uncertainty of exchange rates. Below is an example of what I mean:

Say a trader borrows 5,000 yen from a Japanese bank and converts the funds into U.S. dollars. He then purchases a bond for the equivalent amount, and this bond pays 5 percent or more (and the Japanese interest rate is set at 0 percent). Obviously, this trader stands to make a profit of at least 5 percent as long as the exchange rate between the countries does not change. But if the yen strengthens, this trader is easily wiped out.

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