Carry Trade Analysis: Identifying the Optimal Strategy

Hard Currency Exchange Rates Carry Trade

As a currency strategist at a large investment firm, you are analyzing potential carry trade opportunities in international markets. Currently, you observe the following interest rates for two currencies:

Currency A: 4% interest rate

Currency B: 1% interest rate

You also notice that the current exchange rate of Currency A to Currency B is 1.20, meaning 1 unit of Currency A can be exchanged for 1.20 units of Currency B. Your analysis highlights that geopolitical stability in the region of Currency A has improved significantly, attracting more investment and increasing its demand compared to Currency B. Given this information, you must decide which of the following strategies would benefit most from a carry trade assuming no transaction costs or barriers to capital movement.

Borrow Currency B at 1%, convert it to Currency A, invest in Currency A at 4%, and hedge Currency A back to Currency B.

Invest directly in Currency B at 1%, without any need for hedging, as Currency A is expected to depreciate.

Borrow Currency A at 4%, convert it to Currency B, and invest in Currency B at 1%.

Hint

Submitted9.3K

Correct8.2K

% Correct88%