Carry Trade and Japan's Zero Interest Rate Policy - Essay Example

While on the one hand exports are down and production is down, on the other hand, a large number of job losses is causing a further slide in the economy. This raises curiosity about the importance of carry trade in this scenario. Carry trade, as the name suggests is the trading activity that one indulges in by carrying forward the returns or losses of the holdings by an individual or a business entity. The yen has been a popular instrument amongst the trading community as an important tool for holding foreign exchange and dealing in financial transactions.

Selling the Yen at lower interest rates and then using the funds for purchasing higher interest currencies like the dollar or pounds would yield considerable profits. Such a carry trade prospered, with the hope of sustaining the higher swap ratio and lower interest rates on the Yen. But, with western economies reeling under recession, the Yen has considerably become strong, resulting in some loss-making propositions for carrying trades. This has brought the issue of carry trade into focus. . Such a carry trade prospered, with the hope of sustaining the higher swap ratio and lower interest rates on the Yen. But, with western economies reeling under recession, the Yen has considerably become strong, resulting in some loss-making propositions for carrying trades. This has brought the issue of carry trade into focus.

Economic activities, financial services, and banking have experienced quite a few changes in the last couple of decades. With the opening up of economies, industrial activities saw an upsurge on a global scale. The financial system around the world also saw the need to have a matching regulatory mechanism. The exchange rates became more transparent while investments in one region or country poured in from different corners of the world. The differences in rates of interest, price indices, and exchange rates led to a trading system termed carry trade. 1.1 Background of the study for many years trading in foreign exchange has been a simple process.

It involved buying the currencies with the highest returns while selling those with the lowest. Such a 'carry trade' helped in creating high returns with low volatility. This trend continued for many years creating bumper returns for some investors. Some analysts considered that Carry Trade violated the fundamental theories explaining the markets like the uncovered interest rate parity (UIP).