Download Emerging Market Carry Trades - FMT-HANU

Emerging Market Carry
Trades
1-1
7-1
© 2013 Pearson Education
Emerging Market Carry
Trades
• Incredibly low interest rates in both the United States and Europe,
accompanied by dim economic performance and continuing concern
over fiscal deficits, has led to a new form of carry trade which shorts
the dollar and euro.
• The carry trade has long been associated with Japan and the
relatively low interest rates which its financial community has made
available to multinational investors.
• A form of uncovered interest rate arbitrage (UIA), the Japanese carry
trade was based on an investor raising funds in Japan at low interest
rates and then exchanging the proceeds for a foreign currency in
which the interest rates promised higher relative returns.
• Then, at the end of the term, the investor could potentially exchange
the foreign currency returns, plus interest, back to Japanese yen to
settle the obligation and also, hopefully, a profit.
• The entire risk-return profile of the strategy, however, was based on
the exchange rate at the end of the period being relatively unchanged
from the initial spot rate.
1-2
7-2
© 2013 Pearson Education
Emerging Market Carry
Trades
• The global financial crisis of 2007-2009 has left a marketplace
in which the U.S. Federal Reserve and the European Central
Bank have pursued easy money policies.
• Both central banks, in an effort to maintain high levels of
liquidity and support fragile commercial banking systems,
have kept interest rates at near-zero levels.
• Now global investors, those who see opportunities for profit in
an anemic global economy, are using those same low-cost
funds in the U.S. and Europe to fund uncovered interest
arbitrage activities.
• But what is making this “emerging market carry trade” so
unique is not the interest rates, but the fact that investors are
shorting two of the world’s core currencies, the dollar and the
euro.
1-3
7-3
© 2013 Pearson Education
Global investors are finding it profitable to borrow in the US
or Europe – in dollars or euros -- and invest those funds in
higher yielding interest currencies like the Indian rupee
Exhibit 1 The Euro/Indian Rupee Carry Trade
1-4
7-4
© 2013 Pearson Education
Exhibit 1. Emerging Market Carry
Trades
• An investor borrows EUR 20 million at an incredibly low rate,
say 1.00% per annum or 0.50% for 180 days.
• The EUR 20 million are then exchanged for Indian rupees
(INR), the current spot rate being INR 60.4672 = EUR 1.00.
• The resulting INR 1,209,344,000 are put into an interest
bearing deposit with any of a number of Indian banks
attempting to attract capital.
• The rate of interest offered, 2.50%, is greater than that
available in the dollar, euro, or even yen markets.
• But the critical component of the strategy is not to earn the
higher rupee interest (although that does help), it is the
expectations of the investor over the direction of the INR per
EUR exchange rate.
1-5
7-5
© 2013 Pearson Education
Emerging Market Carry
Trades: Case Questions
1.
Why are interest rates so low in the traditional core
markets of USD and EUR?
2.
What makes this “emerging market carry trade” so
different from traditional forms of uncovered interest
arbitrage?
3.
Why are many investors shorting the dollar and the
euro?
1-6
7-6
© 2013 Pearson Education
Emerging Market Carry
Trades: Submission Guidelines
• General guidelines for electronic submissions
– Assignment Length: 1000 words.
– Format Requirements:
•
•
•
•
•
•
•
Case study answer should be written using MS Word.
Times New Roman
Use black text on a white background.
Use 12 point for the body of your assignment
Use 1.5 spacing and fairly wide margins.
Use bold for headings. Not underlining or italics.
Most assignments require a title page, which should include the following:
– The title and number of the assignment
– The course number and name
– The due date
• Your full name and student number.
• Number all pages except the title page.
• The reference list comes at the end of the assignment, and should start on a
new page labelled 'References'.
1-7
7-7
© 2013 Pearson Education