Interest Rates

Typically people and businesses want to borrow with a low interest rate and lend with a high one. An example of this is the Pound Yen Cross (GBP/JPY). The GBP/JPY cross can provide traders with a an opportunity because they are borrowing the Japanese Yen at a low interest rate and using it to purchase and hold the British Pound at a higher interest rate, which allows the investor to make the money on the interest, as long as the currency pair does not depreciate in value. Obviously this is an ideal situation and there are many other factors involved but this is the outline of how the carry trade works.

Below is a weekly chart of the GBP/JPY cross: As you can see from 2005 to 2007 the GBP/JPY cross appreciated in value. This is because many investors would be drawn to collect the interest from being in this position. Once the interest rates in UK started to decrease and the economic situation in the US and UK started to worsen the GBP/JPY cross started to depreciate. This chart depicts this situation.