Enhancing Risk‐Controlled Returns on Excess Japanese Yen Available to Purchase

This paper examines the zero‐cost risk reversal as a tool for increasing returns to excess yen while limiting risk. With domestic interest rates near zero, firms holding Japanese yen face little opportunity to deposit cash for meaningful gain unless excess funds are invested in an other currency. The conversion strategy is profitable as long as the value of the yen appreciates less than the interest rate differential between the currencies, taking advantage of an apparent empirical regularity frequently referred to as ‘forward exchange bias.’ A problem arises, however, because dollar‐yen exchange rate fluctuation adds variability to returns stated in yen. This increased risk counters prudent cash management principles such as stability of returns and liquidity. We consider the possi bility that effective use of a zero‐cost currency options collar can substantially limit exchange‐rate risk and improve returns to yen holders. Data from July 1997 through June 2002 show that a one‐year strategy of reinvesting collared monthly Eurodollar returns produced a median annual yen return of 1.76 per cent, more than 8 times the median 0.21 per cent Euroyen return; risk also increases but approximately 98 per cent of returns resulting from this strategy fell between ‐6.05 per cent and +12.58 per cent.