FINA 308MINI CASE:Emerging Markets Carry Trade

Nahid Hasanli Shahmar Aghalarov

• INTRODUCTION1. 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 dollars and the euro?

OVERALL

Carry Trade involves borrowing or selling a financial instrument with a lower interest rate and then using it to buy another one with a higher interest rate.

Case Background:

InvestorNet =10%

Japanese BankRate = 5%

Australian Bank

Rate = 15%

After the global crisis, governments and central banks want massive quantities of capital to circulate in their financial systems, by keeping the interest rates near zero.

Target inflation rate

Harmonised Index of Consumer Prices (HICP)

Investors engaged in interest rate arbitrage were only earning from the difference in interest rates without having to worry about movements in exchange rates. However, this emerging market carry trade gives opportunity to investors to boost their profit by benefiting both from interest rate differences and appreciation of emerging markets currencies.

• Constant appreciation of yen in terms of a dollar, decreasing interest rates in eurozone and U.S made yen less popular as a funding currency and started a new trend, which is dollar and euro carry trade.

Would you invest in emerging market currencies?

• Yes, if you believe in constant appreciation of emerging market currencies, you can earn substantial amount of money by investing in those currencies.

Any Question?