Question: Sizeable differences in interest rates between countries may bring about carry trade . Carry trade entails that international investors borrow currencies from countries having a

Sizeable differences in interest rates between countries may bring about carry trade . Carry trade entails that international investors borrow currencies from countries having a low interest rate (the so-called funding currencies) and buy financial assets from countries having a high-interest rate.

(a)

Explain why one can compare carry trade with picking up pennies in front of a steamroller. Use in your explanation the concept of interest-parity condition.

(b)

Explain why the value of funding currencies on the foreign-exchange market falls because of carry trade and explain why the value of the currencies in which carry trading investors invest (investment currencies) on the foreign-exchange market rises.

(c)

Do you think that given your answer to 2b) - carry trade can always be a profitable strategy?

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