Yen strengthens against dollar, euro on hedge fund bankruptcy

Aug 30 | Updated: Aug 31 2007, 05:45am hrs
The yen rose, rebounding from the biggest decline against the dollar since January 2005, after a bankruptcy filing by an Australian hedge fund prompted investors to sell higher-yielding assets purchased with loans from Japan. Japans yen was the best performer of the 16 most-active currencies, gaining by the most against the Australian and New Zealand dollars, after Sydney-based Basis Yield Alpha Fund said US home loan defaults had wrecked the value of its debt holdings. The yen also rebounded from a 2.3% decline versus the euro on Wednesday, when rallying US stocks prompted investors to resume carry trades.

The drip-feed of bad news related to the US housing market looks set to continue for some time, said Derek Halpenny, senior currency strategist at the Bank of Tokyo Mitsubishi UFJ Ltd in London.

The yen is being bought back. Japans currency rose to 115.39 per dollar in New York on Wednesday. The yen advanced to 157.07 per euro from 158.93 on Wednesday, when it fell the most in more than three years. The yen rose as much as 2.2% against the New Zealand dollar, recouping two-thirds of Wednesdays slump, and last traded at 80.86. It gained 1.4% to 94.13 versus Australias dollar. The currencies had been carry-trade favorites, with interest rates as much as 7.75 percentage points higher than in Japan.

In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate.

The risk is that currency market moves erase those profits. Volatility on one-month dollar-yen options rose to 13.4% on Thursday from 12% a week earlier and to 14.5% from 12.4% on euro-yen options.

Higher volatility may discourage carry trades as it implies the bets will be exposed to greater exchange-rate fluctuations.

The yen has gained 7.5% against the dollar since Bear Stearns Cos said on June 22 it would bail out a hedge fund that lost money on securities related to loans to home owners with a poor credit history.