What Is Funding Currency?

Funding currency is any national currency that currently carries a very low interest rate and can be used to buy a wide range of assets that are capable of generating additional returns. Using this approach allows the investor to take advantage of any type of spread that may exist between that currency and the purchased asset. When managed to best effect, the investor is able to enjoy benefits that would not have been possible if a currency carrying a higher rate of interest had been used for the purchase activity.

Use of a funding currency to purchase different types of investments is very common. One strategy calls for using a currency with a low interest rate as part of a foreign exchange or forex investment. With this scenario, the investor uses the currency with the low rate of interest to purchase currency carrying a higher rate of interest. Assuming that the rates of exchange move in the direction projected by that investor, he or she stands to generate a considerable return using this method.

Other types of assets can also be purchased using a funding currency. The approach can be used to acquire various stocks, bonds, and commodities. As the value of those investments increase, this only serves to increase the rate of return that is secured by making the purchases in a currency with a low interest rate.

One of the more appealing characteristics of using funding currency to buy investments is that the strategy carries a relatively low potential for failure. The main potential risk has to do with an unanticipated appreciation of that currency, which would tend to minimize the spread involved and decrease the benefits to the investor. For this reason, choosing the right currency for the funding effort is extremely important, not only in terms of the current rate of interest associated with that funding currency, but also what is likely to happen to the rates in the future.

During most of the first decade of the 21st century, the Japanese yen was often considered the funding currency of choice, owing to the consistently low interest rates associated with the currency. As the worldwide economy entered into a period of recession, the yen began to appreciate in comparison to other national currencies, which in turn made it less appealing for use as funding currency. The shift in funding currency during that recession served to remind many investors that even though identifying a currency with a low interest rate and using it to purchase investments is a viable plan, there will always be some degree of risk involved, making it important to always project future movements before executing a deal.