Effects of Currency Changes on Carry Trade Profitability

Very Hard Currency Exchange Rates Carry Trade

Brazilian investors have recently been engaging in a carry trade by borrowing funds in a low-interest-rate country, such as Japan, and investing in Brazilian government bonds that offer higher yields.

Due to a significant appreciation of the Brazilian real against the yen, these investors have started to assess their positions, focusing on the potential risks and rewards associated with the carry trade strategy.

Which of the following statements best describes how changes in currency exchange rates could affect the profitability of their carry trade?

An appreciation of the Brazilian real against the yen decreases the cost of repaying the borrowed yen, enhancing the profitability of the carry trade.

If the interest rates in Japan rise significantly while Brazilian rates remain unchanged, the carry trade will still remain profitable because currency gains will offset increased borrowing costs.

A depreciation of the Brazilian real against the yen not only increases the cost of repaying the yen borrowing but also diminishes the yield advantage from Brazilian government bonds.

Hint

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