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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory

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To: Jim Willie CB who wrote (28100)	3/8/2005 3:15:05 PM
From: mishedlo	Read Replies (1) of 110194

treasury bonds are 30 yr but there is no reason why one could not do the trade in 30 yr, 10 yr, 5 yr, 2 yr or even 1 yr. On higher denominations one has yield risk in addition to currency risk. The more leverage one put on the more and better hedging they better be doing. I do not think your model included hedging costs. The other place you go wrong is in borrowing x% from Japan and putting on 30y% in US$ and calling the profit on that the "YEN cary trade". For example: Note that one could just as easily borrow 30 million US$ and leverage 30:1 on US treasuries or whatever. Borrowing YEN to do that (when the YEN is expected to rally vs the US$ makes no sense!). With the YEN you borrowed at a cheaper interest rate BUT that borrowing made sense vs borrowing US$ IF AND ONLY IF interest rate differential exceeds the currency loss! For the past two years that has not been the case. Thus in your 30-1 leverage example one would have been better off skipping the YEN portion of your trade and borrowing US$ in the US for say a 2 year term (right at the bottom in interest rates) and investing with leverage in US treasury bonds or the 10-yr. Yes you would have borrowed at 2% and made 5% just as you would have done with a perfect cost free YEN hedge (not that the latter is really possible anyway)! Thus all gains in your model came from your borrowing short lending long with leverage rather than anything that had anything at all to do with YEN! For the last two years the YEN (borrowing) LOST money, even IF the rest of the trade was profitable. It was cheaper and better and required no hedges to just borrow the money right here at short term US rates and leverage into US bonds. If one borrowed YEN and hedged the currency risk, there was no reason to borrow YEN in the first place! If one did not hedge that risk it cost them profits! You have to see this now! Mish

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