Carry Trade Risk Assessment in Currency Markets

Hard Currency Exchange Rates Carry Trade

A currency trader is investigating the potential profits from a carry trade strategy involving two currencies: the U.S. Dollar (USD) and the Australian Dollar (AUD). Currently, the interest rate for USD is 2%, while the interest rate for AUD is 5%. The trader intends to borrow in USD to invest in AUD-denominated assets. When the trader analyzes the potential returns, they consider both interest rate differential and the expected change in the exchange rate over a specific period.

The trader expects the AUD to appreciate against the USD in the coming months. However, there is a significant risk of an economic downturn that could reverse this trend. As a result, the trader must assess the viability of this carry trade given the interest rate levels and prevailing market conditions.

Based on this scenario, what is the most significant risk associated with this carry trade?

The risk from an increase in interest rates in Australia.

The risk of currency depreciation against the initial borrowed currency.

The risk from a narrowing interest rate differential.

Hint

Submitted4.9K

Correct3.1K

% Correct63%