Martin Deutsch via FlickrYesterday, we explained why it is virtually impossible to take out a mortgage, or any other debt, in another currency — as Mark Cuban has done.
Mark Cuban has refinanced all of his debt into Japanese yen, hoping that if the yen falls, then paying his debt off gets even cheaper.
Part of the issue with why the average person can’t get a yen mortgage for their house comes down to banks’ unwillingness to expose their retail clients to excessive foreign currency risk (as well as a new Dodd-Frank financial market reform rule).
That being said, if you’re really commit ed to having yen debt, then replicating the Cuban trade is possible.
Bond trader Ed Bradford, better known as @fullcarry on twitter, explained to us how to mimic the effect of a yen mortgage by trading.
Here’s how you’d do it:
When you have a 30 year mortgage, your are essentially short a bond. It is hard to know the exact maturity of the bond because at the outset you don’t necessarily know when you will sell the house. In the US though we model mortgages as though they have a maturity between 5 and 7 years which seems to be the average holding period when people buy a new home.
So the 10 year UST future (which actually is tied to a bond that has 7 years to maturity) isn’t a perfect match for our mortgage but does tend to track it. By buying the 10 year U.S. treasury future and selling the 10 year Japanese government bond futures ( done in correct proportions), we can get our mortgage to track Japanese interest rates.
And of course, we need to short the Yen vs USD for the correct currency exposure.
As someone on twitter pointed out, it would be much easier to do this with currency forwards. Those allow for the currency exposure to be aligned with the term of the loan directly so you only need that one forward instrument which has interest rate differentials already built in. Currency forwards though require a willing counter party.
Of course, all of this is rather complicated and I wouldn’t recommend it for retail accounts, especially since futures need to be rolled over every quarter and relative sizes need to be adjusted. I just wanted to point out the mechanism.
As another source pointed out to us, this still leaves you exposed to the foreign currency risk retail banks are now trying to shield mainstream clients from — or as he put it, “the Hungary blow up approach.”
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