Question
Lori Jacobson is a foreign exchange trader at Deutsche Bank in Singapore. For her next trade, she decides to embark in the famous carry trade,
Lori Jacobson is a foreign exchange trader at Deutsche Bank in Singapore. For her next trade, she decides to embark in the famous “carry trade”, where you short sell a low-yield currency and use the proceeds to buy and hold a high-yield currency for a certain period of time.
On July 1st, she borrows 100 Million Japanese Yen (JPY) for 1 month, and immediately sells them to buy New Zealand Dollars (NZD) on the foreign exchange market. She deposits the purchased NZD for 1 month. At the 1-month maturity (30 days), she resells the NZD’s (principal + interest) against JPY on the FX market and reimburses its JPY loan.
On July 1st, market rates are as follows:
JPY/NZD foreign exchange rate (bid/ask): 80/85 (Explanation: bid rate is 80 JPY per NZD, and ask rate is 85 JPY per NZD).
1-month JPY interest rate: 0.25%/0.75%
1-month NZD deposit rate: 6%/6.5%
At maturity, the JPY/NZD foreign exchange rate is 82/87.
Assume a 360-day year (12 months of 30 days each)
a. How many NZD’s will Lori receive from the sale of its JPY on July 1st?
b. How many JPY will Lori receive from the re-sale of its NZD at maturity?
c. What was Lori’s net profit (or loss) in Yen on this trade?
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