Subscribe Now!
Journal Of Indexes
Browse Archives
2009
2009
Death Of The Dollar?
November / December 2009
|
Page 3 of 4
An Alternate Index Strategy: The Carry Trade Diversified currency groupings are not the only index innovation to hit the currency space. Increasingly, index-based strategies are allowing investors to take advantage of established currency trading strategies, with the low costs and reliability of index-based investments.7 One example is the carry trade. The carry trade involves taking long positions in currencies with high interest rates and short positions in currencies with low interest rates. The trade capitalizes both on the interest rate differential and on the tendency for high-yielding currencies to appreciate against lower-yielding peers. In its original form, an investor would use the carry trade to try to profit from currencies in much the same way a bank profits on loans: Borrow at low rates, lend at higher rates and capture the difference. In implementing a carry trade, however, the investor is borrowing and lending in different countries, which means he faces exchange rate risk, in addition to the risks of borrowing and lending. The logistics behind this strategy can be complicated and time intensive, which is why this version of the carry trade is conducted primarily by institutional investors. There is, however, another way to approach and profit from the idea behind the carry trade. Interest Rates And Exchange Rates Nobel laureate Robert Mundell is well-known for his work in international macroeconomic theory, particularly for his contribution to the Mundell-Fleming model. Under this model, the exchange rate is one of the primary means by which open economies return to equilibrium after adjustments to their fiscal or monetary policy. The model is based on the premise that when capital is free to move across borders, it tends to seek out places with the highest interest rates. As capital moves from a country with a low interest rate to a country with a higher interest rate, it exerts a corresponding effect on the rate of exchange between the two currencies. For example, a low interest rate in Japan and a higher interest rate in New Zealand would be expected to induce capital flows from Japan to New Zealand. These capital flows would impact the demand for the New Zealand dollar relative to the Japanese yen, and the impact would be reflected in the exchange rate. Implementing The Idea The Deutsche Bank G10 Currency Future Harvest Index – Excess Return, and investable products based on this index, allows investors to access the currency trade through an index-based strategy. The index comprises currency futures contracts on certain G10 currencies. G10 countries maintain floating exchange rates; cooperate on economic, monetary and fiscal matters; and allow relatively free movement of capital. As of July 2009, the G10 currency universe from which the index selects was composed of U.S. dollars, euros, Japanese yen, Canadian dollars, Swiss francs, British pounds, Australian dollars, New Zealand dollars, Norwegian krone and Swedish krona. At any time, the index comprises three long and three short futures positions. The long positions are in the currencies where interest rates are highest, and the short positions are in the currencies where interest rates are lowest. Figure 3 shows the base positions and weights that the index consisted of as of July 2009.  The use of both long and short positions is expected to provide more consistent and less volatile returns than a long-only or short-only position. As a long/short strategy, the carry trade as conducted through the DB index provides exposure to an alternativelike investment with a relatively low correlation to equities (0.54 to the S&P 500 Index).8 It also offers a way to potentially benefit from global macroeconomic trends without additional equity or debt exposure.
|
© Copyright IndexUniverse.com 2009, All rights reserved. Permalink
