Then yen took some lumps over the last 15 years. Japan has a huge trade surplus and its citizens would rather save than spend. One top of that, exports from the country boomed and the carry trade took off and sent the yen down another 45% between 1995 and 2007, reports Stephen Gallo for The Financial Times. [How to Play the Carry Trade With ETFs.]

The tide turned for awhile; Japan’s exports are on the decline and the country’s population is older. Both have eroded yen outflows and have lent strength to the currency. But now, says Mike Kulej at iStockAnalyst, the yen has once again become the cheapest currency to borrow. [3 Things Japan Needs Now.]

Miho Nakuchi for MarketWatch reports that market players who bought the safe-haven Japanese yen did so on growing speculation that the European Union isn’t likely to announce any more specifics on how to solve Greece’s debt problem after the E.U. finance ministers’ meeting. [ETFs to Play Japan.]

For more stories about currency ETFs, visit our currency ETF category.

• PowerShares DB G 10 Currency Harvest (NYSEArca: DBV): DBV can hold positions in any of the following 10 currencies: The U.S. Dollar, the Euro, the Japanese Yen, the Aussie, Canadian and New Zealand Dollars, the Norwegian Krone, the Swedish Krona, the British Pound and the Swiss Franc. DBV tracks an index made up of long futures positions on the three G10 currencies associated with the highest interest rates and short futures positions on the three currencies associated with the lowest interest rates.

• iPath Optimized Currency Carry ETN (NYSEArca: ICI): ICI tracks the Barclays Intelligent Carry Index, which also follows the G10 currencies. Note that ICI is an exchange traded note, so it’s a debt instrument backed by the credit of the issuer. [Differences Between ETFs and ETNs.]

• CurrencyShares Japanese Yen Trust (NYSEArca: FXY)

Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.

Traders engage in carry trade by selling currencies of countries with low interest rates while buying currency of countries with higher rates, writes Jeff D. Opdyke for The Wall Street Journal. However, potential currency investors should know that currency values are volatile, and since currency trading typically involves heavy financial leverage, carry trade can result in steep losses. [Playing the Carry Trade with ETFs.]

The logic behind carry trade is that, over time, high-interest rate currencies will appreciate against low-rate currencies. For instance, the most popular trade of the day involves selling the low-yielding U.S. dollar and buying the high-yielding Australian dollar. Essentially, a trader who builds a position in the Australian dollar borrows the U.S. dollar at U.S. rates and gets paid at a higher Australian rate. [Fed Hikes Rates.]

The carry trade is tricky, which is why ETFs may be an appealing option for many investors who don’t have the time, energy or stomach for the foreign exchange. The two funds below use strategies similar to the carry trade in a convenient, low-cost, transparent format.

For more information on world currencies, visit our currency category.

• PowerShares DB G10 Currency Harvest (NYSEArca: DBV)

• iPath Optimized Currency Carry ETN (NYSEArca: ICI)

Max Chen contributed to this article.

Defensive sectors have led the market over the last few weeks, remarks Gary Gordon for TheStreet, although, it might be because of year-end yield harvesting or efforts to combine cash-flow ETFs with growth ETFs. Among some of the top ETFs leading us out of 2009 include:

• Utilities Select Sector SPDR (NYSEArca: XLU)

• iShares Dow Jones U.S. Telecom (NYSEArca: IYZ)

Additionally, semiconductors and agribusiness are still performing remarkably well.

• SPDR S&P Semiconductor (NYSEArca: XSD)

• Market Vectors Agribusiness ETF (NYSEArca: MOO)

According to Gordon, the U.S. dollar carry trade, or “risk trade,” has a little more juice left to be squeezed out of it for these reasons:

• Government policy. “Risk trade” is the world’s belief that the U.S. interest rates will remain at practically nothing while the dollar remains weak. The U.S. government currently hasn’t shown any initiative in strengthening the dollar, and policies like health care reform, fiscal stimulus and the Fed’s reluctance to change rates have all kept the dollar from appreciating.
• Advisor strategy. Gordon has increased his exposure to utilities and others are doing the same. One ETF-only advisor specifically noted positions in technology, telecoms and utilities because of the prospect of growth with stable cash flows. [An ETF to invest in the "smart-grid" plan.]
• The U.S. dollar. The PowerShares DB U.S. Dollar Index Bullish (NYSEArca: UUP) may have gained recently; however, investors should know that since March, UUP mostly finished every month lower than the month before it. A true trend reversal may need something more substantial. [Gains in the dollar.]

These are some ETFs that help an investor interested in capitalizing on the carry-trade. [Playing the carry-trade with ETFs.]

• PowerShares DB G 10 Currency Harvest (NYSEArca: DBV)

• iPath Optimized Currency Carry ETN (NYSEArca: ICI)

Max Chen contributed to this article.

The carry-trade involves for selling a currency from a low interest rate country and using the proceeds to purchase a currency from a high interest rate country. The idea is not to capture big moves, but to exploit the spread between the two countries’ interest rates, explains ETF professor on Benzinga.

For more stories about currency ETFs, visit our currency ETF category.

ETFs have allowed everyday, individual investors access to capture these movements. These two funds in particular can enable you to do so:

• PowerShares DB G 10 Currency Harvest (NYSEArca: DBV): DBV can hold positions in any of the following 10 currencies: The U.S. Dollar, the Euro, the Japanese Yen, the Aussie, Canadian and New Zealand Dollars, the Norwegian Krone, the Swedish Krona, the British Pound and the Swiss Franc. DBV tracks an index made up of long futures positions on the three G10 currencies associated with the highest interest rates and short futures positions on the three currencies associated with the lowest interest rates.

• iPath Optimized Currency Carry ETN (NYSEArca: ICI): ICI tracks the Barclays Intelligent Carry Index, which also follows the G10 currencies. Note that ICI is an exchange traded note, so it’s a debt instrument backed by the credit of the issuer. (Differences between ETFs and ETNs).

Although there are bragging rights associated with a stronger currency, a weaker currency bodes well for exporting countries. The G-7 meeting in Istanbul talked about how currencies will impact the recovery of their own economies as well as the global economy, writes Bryan Rich for Money and Markets. Mostly, the G-7 wants to see a stronger U.S. dollar sooner rather than later.

Some currencies – the euro, the Canadian dollar, the British pound and the Japanese yen to name a few – appreciated on improvements in global economies, which means a weaker U.S. dollar. Global capital is moving out of the safety of the U.S. dollar and into the rest of the recovering world. (Read here to learn all about currencies).

Governments and central bankers have injected money to help their economies, but the appreciating currencies have counteracted the help. Export-dependent countries are seeing their domestic currencies rise against the world’s biggest consumer, the United States. Some countries are willing to take action to knock down the strength of their domestic currencies to ease their economic recoveries.

An interesting scenario that is occurring with the Japanese yen is the reversal of the carry trade. (What is it?) Investors are now favoring the carry trade with the dollar instead of the yen, and the dollar depreciated while the yen is appreciating.

• PowerShares DB U.S. Dollar Bullish Fund (NYSEArca: UUP): down 8.2% year-to-date

• PowerShares DB U.S. Dollar Bearish Fund (NYSEArca: UDN): up 7.4% year-to-date

• iPath Optimized Currency Carry (NYSEArca: ICI): up 4.3% year-to-date
  

For more information on currencies, visit our currency category.

Max Chen contributed to this article.

Currency ETFs are an easy way for the average investor to gain exposure to world currencies, according to Forex Articles.

Experts note that currency ETFs require an understanding of their risks, how they work and the differences between them, as not all currency ETFs are created alike. An investor may offset individual currency risks by investing in a basket of various currencies, such as in one of these funds:

• Barclays Global Emerging Market Strategy [GEMS] Asia 8 Index ETN (NYSEArca: AYT)
• Barclay’s iPath Optimized Currency Carry Exchange Traded Note (NYSEArca: ICI)
• PowerShares DB G10 Currency Harvest Fund (NYSEArca: DBV)
• WisdomTree Dreyfus Emerging Currency Fund (NYSEArca: CEW)

Economic outlook of the country plays a large role in the strength of a country’s currency and corresponding ETF. A trader needs to consider the outlook, which can be affected by price of oil, trade balance inflation rate, political leadership, war, economic status and many more.

For more information on world currencies, visit our currency category. Or take a look at our ETF currency guide to see what other currency ETFs are available.

Max Chen contributed to this article.

The Forex Market

The foreign exchange market, also known as the forex market, is the largest market in the world. In 2007, for example, it garnered $3.2 trillion worth of transactions each day. It’s the quiet giant of finance and dwarfs all other capital markets worldwide.

Unlike most other trading, such as futures, stocks or options, forex trading doesn’t happen on an exchange. It’s not controlled by any governing body, has no central exchange and there are no clearing houses involved guaranteeing trades. It’s a global network, made up of banks, corporations and individuals. The forex is also the most liquid market – there are always ready and willing buyers and sellers for the currency someone is seeking to trade.

The vast majority of currency trading is done bank-to-bank, and when each party enters into an agreement, they both take on the counterparty risk of the other. They’re not only competitors, but they’ve got to cooperate, as well.

There’s no actual buying and selling in the currency market – only trading, hence the need for cooperation.

Exchange traded funds (ETFs) have made entering this market much easier than it used to be. Prior to the launch of currency-related ETFs in 2005, the forex was a challenging market for individual investors to gain access to. Many investors might find this simplified access appealing, especially when you’re talking about a market that’s open 24 hours a day. If you’ve been eager to play this market, there are a rapidly growing number of opportunities to play the currency markets in the form of both ETFs and exchange traded notes (ETNs), which we’ll detail later.

Currency Basics

When entering the currency market, much of the focus is on the eight major currencies, which give you the best over- or under-valued opportunities. The eight major countries that make up the currency trading market are the United States, the Eurozone (Germany, France, Italy and Spain), Japan, United Kingdom, Switzerland, Australia, Canada and New Zealand.

There are many, many more currencies beyond the eight majors, such as the Brazilian real, Polish zloty and Hungarian forint.

Some of the key points to consider when you’re investing in currencies are:

• When trading currencies, yield drives return. Every currency has a yield.
• The forex allows huge leverage; often as high as 100:1 – which means that you can control $10,000 worth of assets with as little as $100 of capital. Remember, leverage works both ways, though.
• Since currency values never stay the same, the carry trade became a popular theory. Carry traders hope to earn not only the interest rate differential between the two currencies, but also look for their positions to appreciate in value. We’ll discuss this in more detail in the next section.
  
• Interest rates matter – a lot. Becoming familiar with the economics of the country in which the currency you are trading holds will help you understand when inflation is looming and when opportunity is knocking.

In currency markets, there’s always a bull somewhere. Why? The foreign exchange market is all about opposites and all about relativity. As one currency gains value, another has to be losing.

Dan McCabe, CEO at Next Investments, points out that one of the biggest advantages to investing in currencies is that it’s a great way to get non-U.S. dollar exposure.

“As an investor, I have nearly all my stuff in U.S. dollars. When I want to buy something, it’s often foreign-made. If I don’t have a hedge for the fact that the U.S. dollar may depreciate, I’m just losing my buying power on the world stage.”

For example, have a look at this five-year chart of the euro vs. the U.S. dollar. For the last three years, the euro steadily gained before falling off mid-way through 2008:

This means that as the euro gained strength, perhaps tourism in Europe suffered as Americans couldn’t afford to go over there and spend as much. But on the flip side, it likely brought tourists over here who were itching to spend and find bargains. Currency is all about relationships, and a currency being either weak or strong doesn’t necessarily mean it’s bad or good.

McCabe sees currencies as more of a buy-and-hold hedge instead of getting caught up in trading. “You’d rather just come in, buy it and put it away and look at it like a foreign money market account,” he says.

The Carry Trade

One of the most popular ways for institutional investors to play currencies is with the carry trade. Putting it simply, the carry trade involves borrowing currencies from countries with low interest rates and investing it in high interest rate countries. The strategy aims to take advantage of the wide spread in interest rates between certain currencies.

As of June 24, some interest rates for various currencies were:

• Australian Dollar, 3%
• New Zealand Dollar, 2.5%
• Euro, 1%
• U.S. Dollar, 0.25%
• Japanese Yen, 0.1%

You can track these interest rates at Daily FX.

With these interest rates in mind, an investor utilizing the carry trade would want to buy Australian dollars with the much lower-yielding Japanese yen, which is one of the most popular carry trade combinations around.

The carry trade isn’t a risk-free strategy, though. One of the biggest risks is if the exchange rate devalues by more than the average annual yield. If you’re using leverage, your losses could be even greater.

ETFs have simplified the carry trade for retail investors. The PowerShares DB G-10 Currency Harvest (DBV) tracks the interest rates of the U.S. dollar, euro, Japanese yen, Canadian dollar, Swiss franc, British pound, Australian dollar, New Zealand dollar, Norwegian krone and the Swedish krona. DBV looks at the three-month interest rates of the G10 currencies and goes long on the three with the highest rates and short on the three with the lowest. The ETF seeks to capitalize on the trend that the currencies with high interest rates generally tend to rise in value relative to currencies that have low interest rates.

Currency Risks

McCabe points out that currencies are non-correlated assets. “The risk you have oftentimes is performance vs. the underlying currency you’re purchasing in.”

As an example, assume that $1 equals 1 yen. If the dollar increases in value, you might get 1 yen for 90 cents – great if you’re traveling to Japan when this happens. However, it’s not so great if you have an asset priced in yen that you bought when dollars and yens were of equal value.

The flip side also works: if the dollar falls against various currencies, you stand to make money on assets based in those currencies if you bought them before the dollar weakened.

When searching for currencies to invest in, McCabe looks at the country behind it. Political upheaval can wreak havoc on a currency.

“I would look for a stable country with strong jurisprudence and rule of law…a country you believe is going to be stable, in case of turmoil.”

Why Use ETFs Instead?

Investing in currencies on your own, without an ETF, can be an arduous task. The currency market is one that never closes. Twenty-four hours a day, trillions and trillions of dollars in trades are taking place. You could find yourself sitting up in the middle of the night, waiting for a key signal to pounce on a trade.

That probably doesn’t sound like the average retail investor’s idea of a good time.

There are now two options for exchange traded currency investing: ETFs and exchange traded notes (ETNs).

Two key differences between currency ETFs and ETNs are:

1. Currency ETNs (like all ETNs) are backed by the full faith and credit of the issuer. If the issuer goes under, you have to get in line with all the other creditors. It’s a small risk, but it’s one to keep in mind.
2. Currency ETNs linked to a single currency are treated like debt for federal tax purposes, according to a 2007 IRS ruling. It means that any interest is taxable to investors, even though the interest is reinvested and not paid out until the ETN is sold or upon maturity of the contract. It also means that investors can’t elect capital gains treatment.

Not all exchange traded currency products are structured in the same way, either.

McCabe points out that it’s wise to be aware of what makes currency products different from one another. For example, Rydex’s CurrencyShares funds are grantor trusts – they hold the actual currency.

The interest earned on them is accrued on a daily basis and reinvested monthly. This reinvested interest is then reflected in the fund’s net asset value (NAV).

On the other hand, PowerShares‘ currency ETFs, PowerShares DB US Dollar Bullish Fund (UUP) and PowerShares DB US Dollar Bearish Fund (UDN), hold futures contracts and are registered as open-ended ETFs. Any gains from futures contracts are subject to 60/40 tax treatment, in which 60% of the gains are long-term, 40% are short-term.

In the bullish fund, the futures contracts are designed to be long on the U.S. dollar against the euro, yen, pound, canadian dollar, Swedish krona and Swiss franc. The bearish fund is designed to be short on the U.S. dollar against those currencies.

WisdomTree’s currency income ETFs invest in either non-U.S. moey market securities, or in a combination of money market instruments designed to provide exposure to non-U.S. money market securities or rates. They are not money market funds. They seek to give investors current income reflective of foreign money market rates available to U.S. investors, as well as exposure to changes in the value of a specific currency relative to the U.S. dollar.

Market Vectors‘ currency ETNs are senior, unsecured debt securities that give exposure to the exchange rate between U.S. dollars and foreign currencies. The underlying indexes are also affected by movements in interest rates in the country of the underlying currency and that of the United States’.

Market Vectors and ProShares also have some double long and double short ETNs for investors looking to enhance their exposure. They aim to double the daily performance of a specific currency. Know the risks of short and leveraged funds before you invest, however. They aren’t for everyone.

Barclays’ iPath currency ETNs measure the relative values of two currencies. In the EUR/USD fund, for example, when the euro rises against the U.S. dollar, the fund increases, and vice versa. The provider also has a currency carry ETN, iPath Optimized Currency Carry (ICI), that seeks to capture the returns potentially available from a carry trade. The pool of currencies the index may apply its strategies are known as the “G10″ currencies, which includes the U.S. dollar, euro, Japanese yen, Canadian dollar and Swiss franc.

How to Choose

At this point, there are enough ETNs and ETFs targeting currencies that investors have a whole range of choices when it comes to figuring out how they want to play them. When choosing currency ETFs, consider the differences between the available funds, how they access currencies and their tax treatment. In short, know what you own.

Perhaps one of the easiest ways is via a broad basket of currencies, which help spread out the risk and lessen the blows a volatile stock market can deliver. Some examples:

• Barclays Global Emerging Market Strategy [GEMS] Asia 8 Index ETN (AYT)
• Barclay’s iPath Optimized Currency Carry Exchange Traded Note (ICI)
• PowerShares DB G10 Currency Harvest Fund (DBV)
• WisdomTree Dreyfus Emerging Currency Fund (CEW)

There are a number of single-currency funds available, as well, along with a number of others that are in registration:

• PowerShares DB US Dollar Bullish Fund (UUP)
• PowerShares DB US Dollar Bearish Fund (UDN)
• CurrencyShares Australian Dollar Trust (FXA)
• WisdomTree Dreyfus Brazilian Real Fund ETF (BZF)
• CurrencyShares British Pound Sterling Trust (FXB)
• iPath GBP/USD Exchange Rate ETN (GBB)
• CurrencyShares Canadian Dollar Trust (FXC)
• Market Vectors – Chinese Renminbi/USD ETN (CNY)
• WisdomTree Dreyfus Chinese Yuan Fund ETF (CYB)
• CurrencyShares Euro Trust (FXE)
• iPath EUR/USD Exchange Rate ETN (ERO)
• WisdomTree Dreyfus Euro Fund ETF (EU)
• Market Vectors – Indian Rupee/USD ETN (INR)
• WisdomTree Dreyfus Indian Rupee Fund (ICN)
• CurrencyShares Japanese Yen Trust (FXY)
• iPath JPY/USD Exchange Rate ETN (JYN)
• WisdomTree Dreyfus Japanese Yen Fund ETF (JYF)
  
• CurrencyShares Mexican Peso Trust (FXM)
• CurrencyShares Russian Ruble Trust (XRU)
• CurrencyShares Swedish Krona Trust (FXS)
• CurrencyShares Swiss Franc Trust (FXF)
  

There are also leveraged funds, which enable investors to maximize the movements of a particular currency. The following funds all double exposure by 200%:

• ProShares Ultra Yen ETF (YCL)
• ProShares UltraShort Yen ETF (YCS)
• ProShares Ultra Euro ETF (ULE)
• ProShares UltraShort Euro ETF (EUO)
• Market Vectors Double Long Euro ETN (URR)
• Market Vectors Double Short Euro ETN (DRR)

In registration include CurrencyShares for Hong Kong, Singapore and South Africa, as well as WisdomTree funds for the Czech koruna, Chilean peso, Israeli Shekel, the Russian ruble and many more.

Read the disclaimer, as Tom Lydon is a board member of Rydex Funds.

For more stories on currencies, visit our currency ETF category. For more special reports, view our special report page.

1. PowerShares S&P BuyWrite Portfolio (PBP): This ETF is meant for tracking the CBOE S&P 500 BuyWrite Index, which measures the rate of return of an S&P 500 covered call strategy. This strategy consists of holding a portfolio indexed to the S&P 500, and selling a series of call options, each with an exercise price at or above the current level of the S&P 500. The downside risk is hedged and the upside is limited. Why would you use covered calls? Investopedia notes that it’s often done when an investor has a short-term neutral view on the asset, and the strategy is also known as “buy-write.” 888Options also states that this would be used when an investor feels that a fund’s market value will see little range over the lifetime of the call contract.

2. ELEMENTS S&P CTI ETN (LSC): This exchange traded note (ETN) is linked to the S&P Commodity Trends Indicator, which applies a long/short strategy to 6 commodity sectors. This index takes long, short, or flat positions in each commodity based on the exponential average of the prices over the past seven months. In March, Claymore filed with the Securities and Exchange Commission (SEC) for an ETF based on this index.

3. SPDR Barclays Capital Mortgage Backed Bond ETF (MBG): MBG invests in investment-grade mortgage bonds, holds 14 securities, tracks 1,700 components and charges an expense ratio of 0.20%. The fund tracks the Barclays Capital U.S. MBS Index, which covers investment grade, U.S. agency mortgage-backed securities.

4. iPath Optimized Currency Carry ETN (ICI): Another ETN, this strategy is a play on the carry trade. It uses objective and systematic methodologies to capture returns available by investing in high-yielding currencies with the exposure financed by borrowings in low-yielding currencies. ICI is able to invest in currencies of the G10 countries, including the U.S. dollar, Japanese yen and the Australian dollar.

5. MacroShares $100 Oil Up (UOY) and $100 Oil Down (DOY): Issued in pairs, these ETFs (which are actually trusts) allow investors exposure to either upward or downward movements in light sweet crude oil futures contracts. As oil moves up or down, a corresponding dollar amount is transferred between the trusts – for example, if oil moves up $1, then $1 is moved to the up fund and taken from the down fund. Just as their predecessors had been, UOY and DOY are paired products that track the price movements of West Texas intermediate oil. The starting price for a share is $25, representing one-quarter of the benchmark oil price. As the price rises and falls, assets are
transferred back and forth dollar-for-dollar between the Up and Down trusts. The termination trigger for the new funds is $185 a barrel.