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Reading 24 Practice Problem 7

Long term rates are expected to rise and short term rates to fall. My question is, why not carry trade?

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What’s the shape of the yield curve today?

Simplify the complicated side; don't complify the simplicated side.

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Carry trade is best done on stable yield curve. What happens when you try to unwind the carry trade after the yield card steepens as described.

upward sloping

125mph wrote:

Carry trade is best done on stable yield curve. What happens when you try to unwind the carry trade after the yield card steepens as described.

what happens? I am not sure

If you borrow at 1% (short term rates) and then invest at 6% (long term rates)…. and then the yield curve steepens, which raises the rates  to 15%… (exaggerated example of an EM). You try to close out your carry carry trade… what happens to the value?

sinep wrote:

what happens? I am not sure

Ich bin nicht sicher.

If you issue 1-year bonds at 2% and buy 10-year bonds yielding 5%, say, and in 12 months the yields are, respectively, 1% and 7%, you’ve gained about 0.75% on the 2-year bonds and lost about 15% on the 10-year bonds.  (I’m assuming that the effective durations are, respectively, 0.75 years and 7.5 years.  They may be different, but you get the idea.)

Another way to think of it: Why borrow at 2% and invest at 5% today if you believe that tomorrow you can borrow at 1% and invest at 7%?

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

sinep wrote:
Ich bin nicht sicher.

Deshalb sind wir hier, um zu helfen.

(And the fact that I’m not sure about my German is the reason that Google Translate is here to help.  How’d it do?)

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

If rates are expected to change then it’s not a stable yield curve environment. Carry trades are for stable curve expectations. 

Where there is a will there is a way