Essay: Benefits and Risks of a ‘Carry Trade’ Strategy

In the financial markets currencies with forwarding premium will be inclined to depreciate in divergence from exposed interest rates parity. This is an anomaly to literature, but a trading strategy to financial market participants.

The most effective carry trade strategy involves the buying of currencies that have discount forwards to spot prices, and are sold when the forward is at a premium value to current spot[1]. For financial experts, the benefits are realized during the settlement date when differences between the purchase and spot prices for this day are obtained. This practice is often seen in investment banks and hedge funds, where trading is done mainly in index-linked notes or exchange traded funds[2]. Many investors believe that this type of trading is best effective in the increment of the yields for emerging markets. Common traders who use this strategy are speculators and central banks.

[1] Burnside, C., Martin, E., Issac, K. and Sergio, R., The Returns to Currency Speculation (mimeo: Northwestern University Publication, 2006a): 2.

[2] Ibid,

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