The Japanese yen is the best-performing currency this week. It's gained 3.4% over the last few days, which is the biggest increase since December of 2005. With currency carry trades making the headlines, CNBC’s senior economics reporter, Steve Liesman, appeared on "Squawk Box" this morning to give a simple lesson to better understand the yen carry trade.
A currency carry trade is a strategy in which an investor sells a particular currency with a low interest rate and then uses the funds to buy a different currency, capturing the difference between the rates. The big risk in a carry trade--is the uncertainty of exchange rates.
So--here's Liesman’s yen carry trade lesson in a nutshell:
Step 1: Borrow $900 of yen at a low interest rate (example: 0.5%) and turn the yen into U.S. dollars.
Step 2: With $900 from Japan and $100 of your own money, invest the $1,000 in U.S. treasuries at 4.5%.
Step 3: How do the returns work? Collect $45 in interest from your $1,000 and pay $5 to Japan equals net of $40 or a 40% return on the original $100.
Step 4: Convert the money back to yen (hopefully at the same rate).