Currency Carry Trade

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Currency Carry Trade (also CCT , German  interest rate difference business ) is the Anglicism for a speculative strategy in which a trader takes out a loan in a foreign currency with a comparatively low interest rate in order to buy interest- bearing securities or other financial products in another currency with a higher interest rate are noted.

General

He hopes that the higher interest income will result in a profit after repayment of the loan due to the lower cost of capital . The risks involved in this speculation are exchange rate fluctuations and changes in interest rates . Aside from the currency risk, a currency carry trade is worthwhile if the interest expense is lower than the interest income : ${\displaystyle Z_{a}}$ ${\displaystyle Z_{e}}$

${\displaystyle Z_{a}<Z_{e}}$

In order to eliminate the currency risk, the exchange rate risk would have to be eliminated by means of a hedging transaction , which, however, causes transaction costs which, as a rule, correspond to the interest rate difference.

mechanism

The return on currency carry trades is made up of two components:

• the difference between credit and debit interest and
• the exchange rate development .

In order to reduce the risks mentioned, interest rate fluctuations can be eliminated through fixed-income transactions and the exchange rate risk reduced through futures market transactions . However, these hedges reduce the expected return. If the risks were fully hedged , the return would be “zero”, because the herd behavior of all arbitrageurs equalizes the existing spreads , so that the interest rate differential decreases until the arbitrage is no longer worthwhile.

Example
A trader borrows money in yen because he only pays 0.5% interest there and invests in US dollars because he receives 4% here. As long as the exchange rates are stable or, as is usually the case, move in narrow corridors, the business is profitable. However, if the yen rises by more than 10% within a few days, as in the October 2008 crash, then the trader loses money because he has to repay the loan in yen. He therefore tries to get out of business as quickly as possible in order to limit his losses. But this leads to the fact that he buys yen for USD and thereby the yen continues to rise.

relevance

According to the interest parity theory developed by Keynes, such forms of investment are unlikely to pay off because of the arbitrage that sets in. However, contrary to the lack of profitability predicted by theory, currency carry trades have proven to be highly profitable in recent years. The German Bundesbank has calculated for the period from January 1999 to June 2005 a theoretical average annualized return of 15% for a carry trade strategy between Euro and US dollar.

In Bulletin 2008/2, Luxembourg's central bank assumes that the coordinated interest rate cuts by the central banks at the beginning of October 2008 curbed the carry trade and led to speculative positions being liquidated.

The interest rate speculation, in which investors borrow money in countries with low interest rates and a weakening currency, and invest in higher interest countries, amounted to between March and December 2009, when the euro rose from 1.23 to 1.51 US dollars , to $ 1.5 trillion. That sum had a big impact on risky trades like stocks, oil and commodities. After the dollar is appreciated again, the volume of this trade has decreased rapidly.

Delimitations

Currency carry trades are not to be confused with arbitrage trades. With these (which make up by far the largest volume of the foreign currency market ), market participants buy and sell currencies on different exchanges at the same time in order to take advantage of (even minimal) price differences. It is essential that the traders immediately equalize the positions in arbitrage transactions (and thus do not take any market risks ), while the speculators in currency carry trade hold open positions in the respective currencies for the duration of the transaction and thus take risks.

See also : Forex, Foreign Exchange Speculation and Arbitrage section

literature

• Markus K. Brunnermeier , Stefan Nagel, Lasse H.Pedersen: Carry Trades and Currency Crashes. (April 2009). National Bureau of Economic Research ( nber.org PDF; 919 kB).
• Heiner Flassbeck : Carry Trade - The foreign exchange market takes the economy ad absurdum and economists are silent. ( flassbeck.de PDF; 48 kB) FTD, February 8, 2007.
• Jylha, Petri T., Suominen, Matti J. and Lyytinen, Jussi-Pekka: Arbitrage Capital and Currency Carry Trade Returns (November 5, 2008). Available on Social Science Research Network: The paper "provides strong evidence that carry trades are indeed used by arbitrageurs" ("... providing strong evidence that carry trades are indeed used by arbitrageurs"). ( ssrn.com ).
• Erik Heinrich: The Carry Trade: Betting on Bad Currencies. In: Time . February 11, 2010 ( content.time.com ).
• Marko Gränitz: This is how carry trades work . In: TRADERS´ . No. 5 , May 2020, p. 60-61 .

Individual evidence

1. ↑ John Maynard Keynes: A Tract on Monetary Reform. 1923, p. 127.
2. ^ Deutsche Bundesbank: Monthly Report July 2005 , accessed on October 1, 2012.
3. ↑ BCL Bulletin 02/2008
4. ↑ Anna Sleegers: The house of cards collapses. In: Frankfurter Rundschau . October 25, 2008 ( fr.de ).
5. ↑ Christian Schnell: Important currencies are outstripping the euro worldwide. In: Handelsblatt . ( handelsblatt.com ) accessed on February 19, 2010.