25. Plummeting Yen Carry-Trade. The Japanese yen, long the home of the global carry-trade as the lowest

Question:

25. Plummeting Yen Carry-Trade. The Japanese yen, long the home of the global carry-trade as the lowest interest cost source of funds of any major industrial market, began strengthening in August 2007. The yen had remained relatively quiet and above 118/$ for several months. Most analysts and arbitragers believed it would stay at 118, maybe falling to 120. As the U.S. sub-prime mortgage crisis hit in August 2007, U.S. dollar interest rates starting rising, initially adding some momentum to the carry-trade. But then on August 14, the rising concerns over the financial health of the U.S. economy caused a fall in the dollar, and the yen starting appreciating signif- icantly against the dollar (rising quickly to 114/$). This was devastating for the carry-trade, as a rising yen undermined the uncovered interest arbitrage benefits. Within days, things worsened. In an effort to increase the liquidity of the U.S. financial sector fearing rising mortgage-backed securities defaults, the U.S. Federal Reserve lowered the discount rate, which caused a fall in short-term interest rates. Using the following inputs and the exchange rate graphic, using a $1,000,000 notional principal (or Japanese yen equivalent), show how the Japanese yen carry-trade results in a negative invest- ment return after the rise of the yen and the fall of U.S. dollar interest rates:

image text in transcribed

Fantastic news! We've Found the answer you've been seeking!

Step by Step Answer:

Related Book For  book-img-for-question

Fundamentals Of Multinational Finance

ISBN: 9780321541642

3rd Edition

Authors: Michael H. Moffett, Arthur I. Stonehill, David K. Eiteman

Question Posted: