Friend A asked friend B a series of questions. Friend A is not a trader, but a long term investor, so he's not too interested in the details of trading that friend B and myself are now learning about. Friend A is interested in long term carry trades. When friend A received his email reply from friend B he forwarded it to me for a second opinion. To me, some of it sounds dubious at best, but I'm still a novice, so I thought I'd post it here for some thoughts (friend A is in quote marks, otherwise it's friend B):
DislikedBefore I start, a "cross" is simply a pair of currencies that does not include the USD.
"can i leave it indefinitely like i would as a bank?"
Probably depends on the dealer, all dealers would say "yes," I just don't know if one or two would charge any fees? Forex dealers usually only charge "the spread." For what you're talking about that would equal a max of about 10 pips. A meaningless amount for just one or two trades, like you are thinking of.
"will it earn interest in those currencies?"
YES!!! The total amount of money you deposit with your dealer (i.e. your account) will earn interest, along with the dollar value of the forex lots you are "trading." For example, if I'm trading with 100:1 leverage (very common), I put down a margin of $1k for one lot, I'm then earning interest on $100k (or losing interest on $100k, depending on the currency pair or cross I buy/sell). If I'm long the AUD/JPY cross with my forex dealer I am automatically in the most popular carry trade! I presume you could go with 1:1 leverage and have virtually NO risk, and just forget about it for a few years (You'd briefly check the exchange rates and interest rates once a month). Carry trades are awesome! Even for conservative investors.
Or, you could go with the leverage if you like the AUD or at least expect it to stay where it is vs. the JPY - you don't want a decline in the AUD/JPY cross to eat up your carry profits. For instance, if you use the normal 100:1 leverage, and if you knew the long AUD/JPY would be at the approximate same price five years from now (a reasonable proposition), and you put $10,000 down in margin in order to buy 10 lots worth $100k USD each, and assuming the two interest rates stay put: you would make %6.75 AUD - %0.5 JPY = %6.25 per year on $1,000,000 (one million dollars). So *getting out my calculator* you'd make... wait, that can't be right... Fuck!... I LOVE LEVERAGE!!! On your $10k margin requirement, you would make $62,500 per year, X 5 years = $312,500 in interest payments to you alone (I didn't even compound those rates, I'll let you figure that). And, if the Australian dollar gains against the Japanese Yen over that time you would reap those rewards as well!.
So, what's the catch? You're going to have to have more in your account than $10k. $50k would be a safe amount. As mentioned, assuming the AUD/JPY cross exchange rate is the same at the end of five years you've earned $312,500 in interest on a margin investment of only $10k. But, during the five years, this cross will gain and loose value, sometimes in dramatic fashion. When losses do get below your entry point you will need more money from your $50k account to be automatically added to your margin to keep the leverage at 100:1. But then, in our scenario, you would make this money back when the AUD/JPY again increased in value at least to your entry point.
In fact, in five years, I'd say there's a good chance that you'd make a profit on the carry AND the increase in the AUD/JPY cross.
PS in spot forex, which is what we've been talking about, it is not possible to lose more than your account, unlike futures.
"based on what, central banks, private banks etc?"
Based on each country's central bank rates:
"can i then invest it in foreign markets, cd's etc yet still have it denominated in other currencies."
You can do this, but not in conjunction with the forex dealers I've been speaking of. Definitely not when using leverage. Although, with 1:1 leverage (AKA 'no leverage') you may be able to get these currencies from the FX dealers I know of and use them for anything. I'm not sure. However, If you want no leverage, and you just want to buy a currency, why not simply use your local bank? Also, there's an ETF for everything nowadays, not to mention foreign bond funds. With such foreign instruments you'll get the same foreign exchange currency risk/reward as with straight FX trading or investing. You'd be investing in another currency by proxy.