Currency carry trade

The carry of an asset is the return obtained from holding it. It could be an earning or a cost.

Cost of Carrying Inventory

The Cost of Carrying Inventory is expressed as a percentage of each dollar carried on the average in inventory throughout a full year.

What comprises the Cost of Carrying Inventory, besides the money invested?

• space is tied up
• insurance premiums must be paid
• tax levies are set by the state
• material is stolen
• products become obsolete
• people are hired to receive inventory, put it up, move it around, look for it, and count it.

The above list are all “hidden” costs to a degree because no one ever sees a dollar amount listed separately on a financial statement. These expenses are mixed in with a lot of others.

Every company needs to be aware that a Cost of Carrying Inventory exists and how large it has become. It must be considered in nearly every inventory decision. The Cost of Carrying Inventory changes when the prime rate changes.

The cost to carry inventory measures the overhead that an organization carries to support its inventory. In addition to the money originally spent to purchase it, more money will be spent on upkeep while inventory sits in your possession.

The longer the inventory is there, the more it will cost in upkeep. Carrying cost is usually expressed as a percentage that represents the cents per dollar that will be spent on inventory overhead per year.

Currency Carry Trades

Currency carry trades have been a popular speculative strategy among both global investment managers and individual currency traders in recent years. Under this strategy, investors sell low interest rate currencies (funding currencies) and invest in high interest rate currencies investment currencies). The impact of carry trades on financial markets has been reported extensively by financial news media. In particular, the carry trade and stock markets are positively related because they both reflect investors’ risk appetites.

The Carry Trade – Currency carry trade, which consists of selling low interest rate currencies—“funding currencies”—and investing in high interest rate currencies—“investment currencies.” In the 2000s, the term “carry trade” became synonymous with the “yen carry trade”, which involved borrowing in the Japanese yen and investing the proceeds in virtually any asset class that promised a higher rate of return.

The carry trade refers to the investment strategy of going long in high-yield currencies and short in low-yield currencies. In recent years this naïve trade has seen very high returns for long periods, followed by crashes where large depreciations of the high-yield currencies cause large losses. Based on low Sharpe ratios and negative skew, these trades may therefore appear unattractive, even when diversified across many currencies. But more sophisticated conditional trading strategies exhibit more favorable payoffs. The critical conditioning variable, we argue, is the fundamental equilibrium exchange rate. Expected returns are lower, all else equal, when the target currency is overvalued. Like traders, academic researchers should incorporate this information when evaluating trading strategies.

The currency carry trade exploits the forward premium anomaly by borrowing funds in currencies with low interest rates and lending them in currencies with high interest rates. This strategy captures the interest rate differential (carry) between the two currencies, but leaves the investor exposed to fluctuations in the exchange rate between the high interest rate currency and the low interest rate currency. Historically, since high interest rate currencies have tended to appreciate relative to their low interest rate counterparts, the currency exposure has actually turned out to be an additional source of return. As a result, currency carry trades have been characterized by an extremely attractive risk-return trade off.

The returns to currency carry trades are characterized by two main features.

• First, the volatility of the strategy is low and stands at roughly one half the volatility of any given X=USD exchange rate, suggesting that exchange rate innovations are largely uncorrelated in the cross-section.
• Second, although the low volatility allows the total return index to have an extremely smooth upwards progression, the strategy is punctuated with infrequent, but severe, losses.

Credit crisis

A period during which the carry trade loses nearly 20% over a period of three months { as an event study for evaluating the performance of the proposed crash hedging strategies. Interestingly, the carry trade experiences a gradual sequence of adverse moves, rather than a single extreme jump, as typically postulated by models of rare disasters. If option markets fail to appreciate this feature ex ante, rolling short-dated crash protection (e.g. one-month options) is likely to be more expensive than purchasing longer dated options.