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Is there any way to combine FOREX instruments to receive interest on $100K while spending only $2K?

If I buy 100K USDCAD (for example), I only need $2K margin. Every night, I'm charged the difference in interest rates on the entire $100K. This is called the "rollover rate" or "swap rate". It also explains why USDCAD forwards (delivery in 6 months instead of 1 day) have a different price than spot USDCAD.

This makes sense, because everyday I hold on to CAD, the other guy loses a day's worth Canadian interest. Of course, he has "my" USD, and I lose a day of US interest. However, these interest rates are different, so one of us has to pay the other (currently, I'd pay him, since Canadian interest rates are higher, so he's losing more interest than I am).

Now, is there any clever way to combine FOREX transactions so that you receive the US interest on $100K instead of the $2K you deposited as margin?

I know you can do this w/ other currencies, and sometimes make 10%+, but the risk is that the other currency will drop more than 10% (vs the US dollar) in a year, so you end up losing money.

One thought would be to create some sort of triangular arbitrage, so that you're ultimately getting "USDUSD".

I realize that:

  • The law of no arbitrage says this is impossible. However, I don't 100% believe in this law.

  • I actually pay the difference in interest PLUS a broker premium. Since USD has a low interest rate, this premium might wipe out any profit.

  • You can do the same trick w/ FOREX forwards, perhaps even avoiding the broker premium, although you still pay a pip spread.

  • If I setup a triangular purchase, I'm paying the broker spread on 3 different parities, which, again, may negate any profit. Other combinations may be even worse.

  • Depositing $2K to hold $100K is dangerous (unless you've found perfect, instantaneous arbitrage), since 2% is the minimum margin. Something like 5% would be safer.

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    Since you don't 100% believe in the law of no arbitrage, try putting your money where your mouth is. If your lack of belief is strengthened, perhaps you will come back and report on your experiences. – Dilip Sarwate Oct 31 '15 at 16:09
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I'm smart enough to know that the answer to your questions is 'no'. There is no arbitrage scenario where you can trade currencies and be guaranteed a return.

If there were, the thousands of PhD's and quants at hedge funds like DEShaw and Bridgewater would have already figured it out.

You're basically trying to come up with a scenario that is risk free yet yields you better than market interest rates. Impossible.

I'm not smart enough to know why, but my guess is that your statement "I only need $2k margin" is incorrect. You only need $2k as capital, but you are 'borrowing' on margin the other 98k and you'll need to pay interest on that borrowed amount, every day. You also run the risk of your investment turning sour and the trading firm requiring a higher margin.

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    I agree: almost sure it can't happen, but can't figure out WHY it can't. $2K margin is a deposit for delivery. You don't borrow $98K, and you don't pay interest on $98K. You only pay interest on the difference between interest rates, which can actually make you money. – barrycarter Feb 14 '11 at 20:44
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    @barrycarter you could try posting on the quant.se meta site (not the actual site) and basically say 'come help us on personal finance because we're not savvy enough to figure this out' :) I bet they'd know. – Michael Pryor Feb 14 '11 at 21:56
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No free lunch

You cannot receive risk-free interest on more money than you actually put down. The construct you are proposing is called 'Carry Trade', and will yield you the interest-difference in exchange for assuming currency risk.

Negative expectation

In the long run one would expect the higher-yielding currency to devalue faster, at a rate that exactly negates the difference in interest. Net profit is therefore zero in the long run. Now factor in the premium that a (forex) broker charges, and now you may expect losses the size of which depends on the leverage chosen. If there was any way that this could reliably produce a profit even without friction (i.e. roll-over, transaction costs, spread), quants would have already arbitraged it away.

Intransparancy

Additionaly, in my experience true long-term roll-over costs in relation to interest are a lot harder to compute than, for example, the cost of a stock transaction. This makes the whole deal very intransparant.

As to the idea of artificially constructing a USD/USD pair: I regret to tell you that such a construct is not possible.

For further info, see this question on Carry Trade: Why does Currency Carry Trade work?

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I work at a FOREX broker, and can tell you that what you want to do is NOT possible. If someone is telling you it is, they're lying.

You could (in theory) make money from the SWAP (the interest you speak of is called SWAP) if you go both short and long on the same currency, but there are various reasons why this never works.

Furthermore, I don't know of any brokers that are paying positive SWAP (the interest you speak of is called SWAP) on any currency right now.

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Now, is there any clever way to combine FOREX transactions so that you receive the US interest on $100K instead of the $2K you deposited as margin?

Yes, absolutely.

But think about it -- why would the interest rates be different?

Imagine you're making two loans, one for 10,000 USD and one for 10,000 CHF, and you're going to charge a different interest rate on the two loans. Why would you do that? There is really only one reason -- you would charge more interest for the currency that you think is less likely to hold its value such that the expected value of the money you are repaid is the same.

In other words, currencies pay a higher interest when their value is expected to go down and currencies pay a lower interest when their value is expected to go up.

So yes, you could do this. But the profits you make in interest would have to equal the expected loss you would take in the devaluation of the currency. People will only offer you these interest rates if they think the loss will exceed the profit. Unless you know better than them, you will take a loss.

protected by Chris W. Rea Sep 11 at 18:37

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