Read the article "Investors Get Creative for 'Carry' Trade" published on Mar 11, 2015 by Wall Street Journal.
Carry Trades
Incredibly low interest rates in Europe has led to a new form of carry trade which shorts the euro.
The carry trade has long been associated with Japan and the relatively low interest rates which its financial community has made available to multinational investors.
A form of uncovered interest rate arbitrage (UIA), the Japanese carry trade was based on an investor raising funds in Japan at low interest rates and then exchanging the proceeds for a foreign currency in which the interest rates promised higher relative returns.
Then, at the end of the term, the investor could potentially exchange the foreign currency returns, plus interest, back to Japanese yen to settle the obligation and also, hopefully, a profit.
The entire risk-return profile of the strategy, however, was based on the exchange rate at the end of the period being relatively unchanged from the initial spot rate.
Carry Trades: Case Questions
1. Based on what assumption a carry trader would expect profit? Is there risk in the carry trade?
2. Carry trade involves one pair of currencies, one called funding currency and the other target currency. List at least two pairs of such currencies mentioned in the article? Be specific about which is the funding currency and which is the target currency.
3. Among these currencies, why some are considered unconventional?
4. Paul Lambert, head of currency at London-based Insight Investment Management, said "the recent bout of volatility in foreign-exchange markets has made employing the strategy difficult." Explain why.
5. Paresh Upadhyaya, director of currency strategy at Pioneer Investments, said "Monetary policy in the eurozone supporting the euro trend makes it a no-brainer for using the euro as a funding currency." Explain why?
Attachment:- Assignment Files.rar