Lesson 1. The Carry Trade

Currencies are valued through interest rates. The Central Bank of a country ( Bank of England / Bank of Japan / Federal Reserve / European Central Bank etc) sets an interest rate at which retail banks (Barclays etc) can borrow and deposit money from it, just like the retail banks (Barclays etc) do for us. However it is far simpler as central banks can only set one interest rate for both deposits and loans. Ie the Bank of Japan let's you borrow and deposit Yen for 0.1%, the ECB's rate for the Euro is 0.75%. All one then does is borrow cheap money (Yen) from a Central Bank with a low interest rate (BoJ) , then deposit it (as Euros) at a Central Bank offering a high interest rate (ECB). You then profit from the difference in interest rates (0.75 - 0.1 = 0.65%) and as the demand for the high interest rate currency (Euros) increases it will of course further increase in value. Thus when you eventually sell your Euros, you will be able to buy back more yen and be richer. This is called the Carry Trade it is the most important currency strategy and all investment banks do it.