460Case#2

460Case#2 - Economics 460 Case 2: Facing Up to the Carry...

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Economics 460 Spring 2010 Case 2: Facing Up to the Carry Trade 1. What is the impact of the carry trade on the spot and forward exchange rates of the Euro in terms of Australian dollars? Should this be grounds for concern among finance ministers in Europe? Explain. The carry trade is the name for speculation in foreign exchange markets that involves borrowing funds in a low-interest-rate country, converting the funds to the foreign currency of a high-interest-rate country, and investing those funds in the high-interest-rate country through purchase of equity and debt. This will be profitable so long as the spot exchange rate of the low-interest-rate country does not appreciate too much before the foreign investment matures. In our example, the European Union has the low interest rate and Australia has high interest rate. The carry trade will cause the Euro spot exchange rate to depreciate, as carry traders sell Euros to buy Australian dollars. Carry traders do not hedge these investments, so they do not transact in the forward
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460Case#2 - Economics 460 Case 2: Facing Up to the Carry...

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