5) Carry Trade pg 74

5) Carry Trade pg 74 The carry trade is the investment strategy of going long in high-yield target currencies and short in low-yield funding currencies. The carry trade is one of the most simple strategies for currency trading that exists.

Carry Trade Fundamentals • The carry trade fundamentals. • The aim/ objective of the Carry Trade is to profit from interest rate DIFFERENTIALS. • That is to borrow in one currency with a "low yield" and invest in one or more "high yield" currencies. • Typically the Japanese Yen- has been the "funding currency of choice for "carry trade" purposes.

"Mrs Watanabe"- The Kimono Trader • Let's watch this short video. • http://jp.reuters.com/video/2011/03/30/japans-hedge-fund-housewives?videoId=199153009 • I want you to think of a few questions using this structure. • If I were the Interviewer I would have asked her..............

If I were the interviewer I would have asked.................. • Third Conditional examples • (The third conditional talks about the past) We talk about a condition in the past that did not happen ! • An example of the third conditional. • If I had won the lottery (last Saturday) I would have bought a car.

If I were the Interviewer I'd have asked............ • EX: If I were the interviewer I'd have asked her how much leverage she uses ! • EX: If I were the interviewer I'd have asked her which currency pair she dislikes. • Do you have any other comments on this ? • What are some adjectives you would use to describe currency trading (retail in this case)

Carry Trade Fundamentals cont. • Although the Carry Trade can result in large gains through INTEREST RATE Differentials and Currency Appreciation (and opportunities for Arbitrage.) • What is the underlying risk involved in Carry Trade Activity. ?

If you said (or thought) Currency Depreciation • you are CORRECT ! There is Currency Risk ! • There is EXPOSURE to the high yielding currency depreciating in value compared to the "funding" or borrowed currency. • Right now, the US Dollar is the currency "in vogue" for carry trade activity. There is a fear that selling pressure will depreciate the dollars value to even lower than it is today. (Law of S and D)

Short and Long positions in FX • Think of the short position Yukiko san is in in the video. • Definition of 'Short’ (or Short Position) • A trader is in a SHORT POSITION when she sells a currency pair. • “Going Long” is the opposite of “going short”. The trader is in a LONG POSITION when she buys a CURRENCY PAIR.

The size of the FX Market • Tokyo’s spot currency market is currently averaging about about $58bn • One analyst estimated such small operators (with fewer than 15 employees) could account for as much as 20-30 per cent of total FX trading volume in Japan.

Let's look at a possible scenario: Let's assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% as long as the _________________between the countries does not change. Many professional traders use this trade because the gains can become very large when _____________is taken into consideration.

Short Selling pg 72 • Short selling is making money on a share even when its price is falling. • This is not an easy concept to understand. • Please consider these two questions. • 1. How can you sell something you don't own ? • 2. What does "America's market regulator" refer to ?

Short selling continued. • Short selling is a bet AGAINST a company's share price. • The Investor (Speculator) expects the stock price to go down. • "Shorting" a stock is the opposite of buying a stock which is often referred to as "going long".

Short selling- a basic approach- short selling can lead to unlimited losses because in theory share prices can increase indefinitely. • $ 300 • $ 100 • $ 0

A few more more points about short selling. • Most liquid stocks can be borrowed for a long time (for the short-seller to keep short position) • Short-selling has a negative image almost everywhere because it is linked to speculation. • Most countries with a developed financial market have implemented short-selling bans since the summer of 2008.

The size of the Spot FX Market • Tokyo’s spot currency market is currently averaging about Y5,000bn — or about $58bn per day • One analyst estimated such small operators (with fewer than 15 employees) could account for as much as 20-30 per cent of total FX trading volume in Japan.

Some background on short selling • In 1609, Mr. Le Maire, one of the key shareholders of the DEI Company sold more shares in the company than he held. • (meaning he borrowed shares off another counter-party) • He bet that the share price would fall with the rise of a French competitor. • That assumption did not materialize. The company’s share price rose back and Le Maire was unable to buy back the shares to deliver them.

26) Investment Banking • An Investment bank, simply put, is an intermediary organization that uses its expertise and financial knowledge to make possible for companies, institutions and governments to take advantage of business or investment opportunities • Let’s list the ones that you know. What else do you know about them ? What happened to Lehman's assets in Asia Pac. after they filed for chapter 11?

IB Divisions • Investment Banks usually operate a number of different business divisions. Sometimes these divisions are referred to as “arms”. • Are you familiar with any of them ?

Argument against Investment Banks • Some people say these “Investment" banks don't have nearly enough real private capital to cover the bets on derivatives they are underwriting. • whether it be swaps or options, futures etc

These divisions usually include • RETAIL • GLOBAL MARKETS • INVESTMENT BANKING (Advising on M and A, providing project finance etc) • ASSET MANAGEMENT • MERCHANT BANKING (focus on Private Equity) • What is the situation in Japan ? Are there similar structures used ? What are the differences in IB Structure if there are any ?

2) Universal Bank pg. 82 • A universal bank participates in many kinds of banking activities and is both a commercial bank and an investment bank.

UNIVERSAL BANKS AND THE GLASS STEAGALL ACT(GSA) • The concept (of Universal Banks) is most relevant in the UK and the US, where historically there was a legal difference between pure investment banks and commercial banks. • In the US, this was a result of the Glass Stegall Act of 1933. In both countries, however, the regulatory barrier to the combination of investment banks and commercial banks has largely been removed (In the US through the GSA)

Recap: So what did the GSA do ? • The GSA prohibited banks from accepting deposits and underwriting securities. • Everyone should understand that the GSA made it ILLEGAL to combine Investment and Commercial/Retail Banking. • Lets refer to the Financial crisis video.

GSA and GLB: Legal Framework in the Financial Markets • If the GLB Act hadn’t repealed the GSA then…………….. • The GSA would have prevented the Mortgage Lender from selling the mortgage to the Investment Banker. • That may have prevented the crisis right there. (As you know MBS were a product at the core of the GFC)

REVENUE MIXpg 86 • So we have looked at the different divisions Investment Banks operate. • Now, let us take a look at where they receive their revenue from: • Please call them out as they are listed on pg. 86 • 1. UNDERWRITING Revenues 2. Trading Income 3. Commission 4. REPOS

BEHAVIOURAL ECONOMICS AND FINANCE pg. 98 • Behavioral finance is the study of the influence of psychology on the behavior of financial decision makers and the subsequent effect on markets. • Why is it necessary (for some people) to understand this field very well ?

EXCHANGES pg. 108AND OTC MARKETS • Definition: • Exchange: The place in which the trading of goods, stocks, commodities, currencies or other financial instruments occurs. • Lets have a look at the characteristics of each • Over-The-Counter Market - • A decentralized market of securities not listed on an exchange where market participants trade over the telephone, facsimile or electronic network mail/network

OTC markets are usually not regulated. There is less Liquidity. • Examples of OTC markets include forex trading markets, as well as markets for buying and selling debt. • Over-the-counter markets have overtaken exchange markets in terms of volumes traded daily.

In exchange markets, there’s a regulator (The Exchange) through which transactions are completed, • While in OTC markets there is no regulator. • Exchange markets have less chances of price manipulation. • On the other hand competing traders in OTC markets can manipulate prices. (key benchmarks) • Exchange markets ensure transaction security. • Historical Data is much easier to obtain on Exchange traded products.

Sovereign Wealth Funds pg 114 • - SWF' • Pools of money derived from a country's reserves, which are set aside for investment purposes that will benefit the country's economy and citizens. • The funding for a sovereign wealth fund (SWF) comes from a central bank reserves that accumulate as a result of budget and trade surpluses。

5) Carry Trade pg 74