Carry trade

CFA Level III Derivatives
#1

Honestly I have not completely read SS 14-Currency management.

I just stumpled EOC (Schwbook4) question about carry trade.

I do not know what is a carry trade.

Can someone who is alread been through this subject in this forum, can refer me to the select threads (from an examination execution perspective)

Please make my life easy.

#2

A carry trade is the hope that currency exchange rates won’t follow interest rate parity. You have a borrowing (cheap, low interest rate) currency and an investing (high interest rate) currency. You:

  1. Borrow the cheap currency at the (low) risk-free rate.
  2. Convert the cheap currency to the investing currency at the spot exchange rate.
  3. Invest the investing currency at the (high) risk-free rate.
  4. Wait. Patiently.
  5. Convert the investing currency plus (lots of) interest to the cheap currency at the prevailing spot rate.
  6. Pay off the cheap currency loan.
  7. Party with the profits.

Of course, because you haven’t locked in the future exchange rate with a forward contract, it could change against you and wipe out all of your gains. This happens from time to time.

#3

s2000magician,

A big thank you.

Does cheap currency mean the one with the lower Risk free rate.

Also does cheap currency mean low yielding currency

I must be thankful to finquiz. The amount of practice using their item set questions and ofcourse reading articles from AF has clear lot of my doubts.

When I read the currency management chapter (SS 14) for the very first time, I have stumbled on the following few points:

Sch book4, Pg 111

From the table given,

Q2: which foreign currency hedged would earn a positive roll return?

Q4. Comment on how the roll yield affects the decision to hedge the EUR/USD

Q5. Calculate the implied unannualized roll yield of a currency hedged for the portfolio’s long exposure to CHF

I do not want to ask you work the numbers for me.

It is just that probably when you explain I retain things better.

Kindly explain what is the approach taken to address the above questions, and how do we interpret the outcomes.

Please help.

#4

You’re quite welcome.

Yes.

Yes.

Unfortunately, I don’t have the current Level III Schweser books, so I cannot see the table.

In general, a currency will (likely) earn a positive roll yield if the forward points are negative; i.e., the forward rate is lower than the spot rate. I say “likely” because the actual roll yield earned will depend on how the spot rate changes, which cannot be known beforehand. A positive roll yield would make you more inclined to hedge than would a negative roll yield, all else equal.

#5

This real life example will help you remember it: http://useconomy.about.com/od/glossary/g/yen_carry_trade.htm

#6

Bump

S2000 youve saved us agan.