Effects of Carry Trade on Currency Exchange Rates

Medium Currency Exchange Rates Carry Trade

In a carry trade strategy, an investor borrows funds in a currency with a low interest rate and invests in a currency with a higher interest rate. Recently, the investor has noticed that the difference in interest rates between the Japanese yen (JPY) and the Australian dollar (AUD) is significant. The JPY is offering an interest rate of 0.1%, while the AUD is yielding 4.0%.

As the investor considers the exchange rate dynamics and the risks involved, which of the following outcomes is most likely to occur as a result of this carry trade?

The JPY will strengthen against the AUD over time, causing the carry trade to become unprofitable.

The investor will benefit from both the interest rate differential and a potential appreciation of the AUD against the JPY.

The investor will incur a loss from both the interest rate differential and a decline in the value of the AUD relative to the JPY.

Hint

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