The carry trade is very popular for people who manage big amounts of money.
Easy Example:
Let's say you have 1M Euros and you could leverage that amount at 20:1.
You take your newly Euros 20 million and buy EURJPY. Currency rates is 4.25 for Euro and 0.5 for JPY. Difference is 3.75 y/y. 20M x 3.75% is 750000 Euros profit without do nothing.
Ok, that's are the easy maths. But you would be affected by the currencies movements during the long year.
Because our main focus is to profit just with the interest rate differentials we could choose some strategies to hedge the position limiting the risk.
Our friends form Investopedia will help us with the rest:
Quote:
A forward contract in the forex market that locks in the price at which an entity can buy or sell a currency on a future date. Also known as "outright forward currency transaction", "forward outright" or "FX forward".
In currency forward contracts, the contract holders are obligated to buy or sell the currency at a specified price, at a specified quantity and on a specified future date. These contracts cannot be transferred.
|
Quote:
describe a type of transaction in which two parties agree to buy or sell a given amount of currency at a predetermined rate at some point in the future. This type of transaction is also known as a forward outright, an FX forward or a currency forward. A forward outright transaction is mainly used by parties who are seeking to hedge against adverse currency fluctuations or to stabilize a stream of future cash flows by taking advantage of the current rate.
For example, let's say a U.S company known as ZXY imports most of its materials from the U.K. every six months and the executives believe that the value of the domestic currency is going to decrease. If the domestic currency's value does decrease, it will take more U.S. dollars to buy the same amount of materials. In this case, a forward outright transaction would be appropriate: the two parties involved can agree on a certain exchange rate today, and when ZXY needs to purchase materials in six months, it will not be affected by adverse changes in the exchange rate.
An outright rate differs from the rate used in the spot market because the parties factor in characteristics such as the volatility of the currencies and their mutual opinion of where they think the exchange rate will be in the future. The disadvantage of using a forward outright is seen when the exchange rate moves in what would have been a favorable direction had the hedge not been implemented. Because the investor agreed to pay a predetermined exchange rate - regardless of what the rate ends up being when the investor makes the purchase - the investor doesn't stand to gain from favorable changes in the exchange rate.
|
The main problem with this type of transaction is the same as any other option trades. What if the currency moves against us.
We buy a forward outright to buy EURJPY today at 161.79. If during August 2009 EURJPY is again =< to 161.79 we made a good choice but what if price is lower?.
Linear Mode
