Borrow Low - Lend High
By: Ellie Taft
The following is an excerpt from Ellie Taft's Dad’s Legacy-How You Can Support Your American Dream with a Winning FX Trifecta
Do you know what economists mean when they claim Japan is financing the American consumer? The explanation is really quite interesting. Please, allow me…
The lending rate at the central Bank of Japan is 0.5%. The US Fed rate was 4.25%, as of January 1, 2008. So, investors can borrow money in Japan at 0.5% and earn 4.25% guaranteed interest when they deposit that borrowed money in a US bank.
Wow… talk about a great gift! I’m sure you’re wondering, “Can I really gain a steady cash flow from borrowed money?” And the answer is YES.
Since 2003 Japan has flooded the market with over 20-Trillion Yen at 0% to .5% interest. Why? Because the Japanese know that as soon as their cheap money gets deposited in countries like the USA, Great Britain and Canada, consumers will borrow it to buy cars and electronics made in Japan. Pretty clever, don’t you think?
Of course, the Japanese aren’t the only ones manipulating their homeland economy with interest rates. Just look at the wild ride Alan Greenspan took Americans on starting in 1987. And now, after 20 years of Greenspanomics, we have the Fed tinkering with rates every chance they get… and savvy Forex traders love it!
You see, every time you enter the Forex market, you either pay or earn the interest rate differential on the full contract amount. Stay on the receiving end, and you’ll be amazed how fast the cash adds up.
Forex is a “spot” market, which means cash-on-the-spot rather than some time in the future, as with commodities. Figuratively speaking, if you buy USD/JPY, you write a check against the Bank of Japan and deposit it in the US Federal Reserve System. All transactions must be settled in two business days. So, Forex brokers automatically “roll” any position open at the end of the day over to the next settlement date. Since you don’t actually have any money deposited in Japan, you pay 0.5% interest to borrow sufficient funds to cover your “check”. And then you earn 4.25% for having it deposited in the United States!
Some people refer to the net interest as the “Roll Rate” because it is calculated daily, every time the contract “rolls over”. Others refer to it by the financial term of “Carry”, which is the difference between the cost of financing an asset and the asset’s cash yield. When you hold a long position, you earn the interest of the first currency and pay the interest of the second currency; and vice versa when you’re short.
Although the “Central Bank Rate” gives you a general idea of what the carry interest will be the precise amount varies day to day and bank to bank… just like loan rates on a local basis. The main thing to remember is this… you can gain a real profit-boosting advantage from leveraged interest.
Every day at 5 PM EST, “Carry Interest” is tallied up for the full contract amount and posted to your account. In other words, if at 5:00 you’re holding a mini position with positive yield, such as the New Zealand Dollar at 8.25% versus the Japanese Yen at 0.5%, you’ll earn interest on the full 10,000 units even though, at 100:1 margin you only put up $76! And every Wednesday, triple interest will be posted to your account to make up for the weekend… even if you didn’t enter the trade until that day!
So, going by the table below, if Wednesday afternoon you put up $2,000 to buy one full size GBP/JPY contract, you could expect $81.06 interest to be posted to your account before the day is out.
On Wednesdays, traders who hold a currency pair that pays high interest like GBP/JPY tend to stay put until after the triple-day interest is posted. But, about 90% of the time, a sell-off of at least 20 pips will follow the 5 PM rollover posting. An astute scalper could make themselves a very nice weekly bonus of this one predictable little move!
Two Occasions When “Rollover” Fees Do Not Apply
There are two exceptions to the “Rollover” norm.
- Accounts leveraged at greater than 100:1 are generally denied the privilege of earning the rollover fee. However, they are charged the cost of carry if they hold their position past 5 PM EST. For this reason, usually only day traders elect leverage rates higher than 100:1.
- It is against the Muslim religion to either earn or pay interest of any kind. So “Muslim friendly” brokerage firms absorb the carry costs and allow Muslims to trade interest free.
A trader once told me about opening a “Muslim friendly” account with one broker and a regular account with another. He said that he then went long AUD/JPY with the interest paying broker and hedged by going short with the interest-free broker. “You just can’t lose”, he told me. I admit, it did sound intriguing. So I asked a prominent FX broker about their “Muslim friendly” accounts. He told me you must be a Muslim to qualify. But even then, it’s not such a good deal, (at least not to his firm) because they charge enough commission on the no-interest accounts to more than make up for the interest! In the end, I guess there’s still no such thing as a “Risk-Free” trade.