Well let's use the amount of cash that the trader actually deposits with the broker as the starting point since that's what the returns are based on. In your example you used $100.
If my broker allows up to 100:1 leverage (a typical amount) then I am able to enter positions with dollar values equal to my deposit multiplied by my leverage ($100 x 100 = $10,000).
I don't have to take positions that are this large, but let's look at the riskiest scenario, where I use all my available leverage. In that case, I can go long $10,000 worth of the USD/JPY. This means I would be long $10,000 and short 1,200,000 yen (at 120 to the dollar).
Some Japanese bank would have to loan my broker this yen, and I would be liable for the interest on it, so that would amount to 0.50% x 1,200,000 yen or 6000 yen per year. This is equivalent to $50 per year in interest that I would have to pay the Japanese bank.
On the other hand, I've converted those borrowed yen into 10,000 dollars which I have on deposit at a U.S. bank at about 5.0%. So I would be receiving $500 a year on that deposit.
My net interest is $500 - $50 = $450 per year. This is a 450% return on my $100 deposit. The easy way to get this number is just to multiply the interest rate spread by the leverage. The spread between Japan and the U.S. is about 4.5%, so multiplying by my 100:1 leverage = 450%.
Now what happens if the dollar drops to only 119 yen? I am short 1,200,000 yen, and originally that was balanced by my equivalent $10,000 long position in dollars. But now my dollars are only worth 1,190,000 yen. In order for me to pay back my loan from Japan, I need to come up with 10,000 more yen. At 119 to the dollar, this would cost me 10,000/119 = $84.
That doesn't seem like much, but it just about wipes me out. Remember, my account only really has a deposit of $100. I have lost 84% of that. In real life, this would cause a margin call, the broker would liquidate the position, subtract the realized loss of $84 and I would be left with $16 sitting in my account.
This is why AIM doesn't go well with this kind of an account structure. AIM thrives on volatility, but volatility with high leverage is an account killer.
AI
