Carry trade
Borrowing in a low-interest currency to invest in a high-interest one, betting that uncovered interest parity fails. Steady gains in calm markets, and sudden large losses when funding currencies rally in a crisis.
Where you will meet it
Carry trade appears in 8 learning outcomes on the CFA syllabus. A few of them:
- Discuss relative value hedge fund strategies: their investment features, how they are put into practice and the role they play in a portfolio
“Fixed-income arbitrage exploits anomalies such as yield curve kinks, on-the-run versus off-the-run bonds, swap spreads or carry trades; leverage can be very high and positions suffer when liquidity dries up.”
- Judge how well today's spot rate, the forward rate, uncovered interest parity and purchasing power parity each forecast future spot rates
“In practice high-yield currencies often weaken by less, or strengthen, which is why forwards forecast poorly and carry trades can pay.”
- Build a positioning strategy from forward rates when the manager's rate outlook agrees with what the market implies
“Strategies include buy-and-hold at a target duration; rolling down an upward-sloping curve by holding bonds whose yields fall as they age; repo-financed carry trades that borrow short to hold higher-yielding longer bonds; long futures or receive-fixed swaps as leveraged equivalents; and selling options, such as covered calls, to collect premium.”
- Set out the main approaches used to forecast currency movements
“Uncovered interest parity implies higher-yield currencies should depreciate, yet carry trades often profit for long periods before sharp reversals.”
See also
Practise it
Practise carry trade until it is automatic: questions that explain every wrong option.
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