Emerging market carry trade PDF

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Running head: EMERGING MARKET CARRY TRADE

Emerging market carry trade Student’s Name: Institutional Affiliation:

Carry trade focuses on borrowing or selling of financial instruments with reduced interest rate and then using the instrument to purchase another financial instrument which has a higher rate of interest. 1. Why are interest rates so low in the traditional core markets of USD and EUR?

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EMERGING MARKET CARRY TRADE

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The Central Banks of both the United States of America and Europe have kept a low level of interest rates during crisis times to secure a certain degree of liquidity in the markets and to support the fragile banking system. The objective of this methodology is to give liquidity to banks which were relied upon to forward an acceptable piece of this liquidity to the economies through credits thereby allowing for massive circulation of capital in their financial systems (Aghalarov, 2013). 2. What makes this "emerging market carry trade" so different from traditional forms of uncovered interest arbitrage? It is unusual that the spot exchange rates INR/EUR strengthens from INR 60.4672/EUR to INR 56/EUR, which will lead to extra profit when changing INR back into EUR. Such a strategy is aimed at earning an extremely high return on the appreciation of the Indian rupee towards the Euro, whereas usually the carry trade is focused on gaining profit on interest rate differences between the two currencies. Furthermore, what makes it considerably different is the fact that normally the Japanese Yen was the platform for gaining cheap credit and exchanging the Yen into USD or EUR, which is then invested at better interest rates. However, it is now seen that the main currencies EUR and USD provide cheap credits which are converted into currencies of emerging markets like India or China, as they offer more favourable interest rates for investments. Therefore, the investors continue to boost their profits through benefiting from both interest rate difference and the appreciation of emerging markets (Iei.liu.se, 2015). 3. Why are many investors shorting the dollar and the euro? The US and the Eurozone currently have very low-interest rates and high debts. As it is possible to borrow cheap in EUR or USD and to invest in other currencies at more favorable

EMERGING MARKET CARRY TRADE

interest rates, many investors short the EUR or USD and buy e.g. currencies of emerging markets, which show a steady economic growth and decent inflation. Thus, these currencies are expected to strengthen, which will cause a weaker EUR or USD and better exchange rates when changing the emerging market currencies back into EUR or USD. Through this, high profit is realized.

References Aghalarov, S. (2013). Emerging Markets Carry Trade. Slideshare.net. Retrieved 10 February 2016, from http://www.slideshare.net/shahmaragalarov/new-microsoft-power-point29580503 Iei.liu.se, (2015). Emerging Market Carry Trades. Retrieved 10 February 2016, from https://www.iei.liu.se/fek/frist/723G33/yinghongfiles/1.463799/emergingmarketcarrytradechanged.ppt.

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