The interest rates associated with individual currencies are one of the most obvious yet least-understood forces in the foreign exchange marketplace. Their most negative effects capture public attention during carry-trade bubbles, such as the recent (summer 2007) rise—and then abrupt fall—of the New Zealand dollar versus the Japanese yen. But day-to-day, currency traders are misled by a broken market mechanism that encourages pricing to skew away from any connection with reality.
In the following interview, Richard Olsen, co-founder of OANDA, discusses this little-understood issue. The solution he recommends—and has put into practice at Olsen and OANDA, the prominent online forex brokerage he founded in 1995—is continuous interest-rate payment, second-by-second, on all open positions.
Continuous interest makes the yield component of every currency transaction real. In a marketplace where fundamentals are few and far between, and where pricing tends to lack any fundamental frame of reference, continuous interest will help stabilize markets and enable incremental intervention to avoid valuation free-falls…
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