Carry Trade

CFA Level II
#1

Hi guys… I am having serious problem with the exercises… teorically I understand that you borrow in low yield currency, then buy high yield currency, invest in high yield currency and the sell it and buying back your kow yield currency and pays the interest. However when I doind the exercise I don’t get it…

Someone could explain me this exercise please.

All in return in Carry trade in JPY

1Y Libor JPY: 0.15% 1Y Libor EUR: 1.4%

Spot JPY/EUR 127.629/ 127.932 1Y Spot JPY/EUR 129.963

What I am doing is converting this Fx to EUR/JPY using bid=1/offer and offer=1/bid, after that I “buy” EUR using my new offer then multiplied by 1.014 and divided by “selling” EUR by the spot rate of 1Y… finally I rest 0.15%… What I am doing wrong? or how can I solve this type of exercise easily?

Thanks!!!

#2

I would have done it the same way as you.

#3

I seem to remember this one, did you figure out which one is base currency which one is price currency?

#4

It doesn’t matter.

#5
  1. Borrow, say, JPY 1,000,000 @ 0.15%
  2. Convert that to EUR at today’s spot rate: JPY 1,000,000 ÷ JPY 127.932* / EUR 1.0 = EUR 7,816.6526
  3. Invest EUR 7,816.6526 @ 1.4% for 1 year; it grows to EUR 7,926.0857
  4. Convert that to JPY at the spot rate one year from today: EUR 7,926.0857 × JPY 129.963 / EUR 1.0 = JPY 1,030,097.88
  5. Pay off the loan of JPY 1,000,000 plus interest: JPY 1,001,500
  6. Your profit is JPY 28,597.88

*If you have to divide (as you do here), divide by the bigger number; if you have to multiply, multiply by the smaller number. You will always end up with the smaller amount of the new currency.

Notice that nowhere in there did I mention price currency or base currency. It doesn’t matter.