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Homework answers / question archive / Which of the following two statements is true? S1: In a carry trade, a speculator borrows in the high interest rate currency and deposits the funds in the low interest rate currency
Which of the following two statements is true? S1: In a carry trade, a speculator borrows in the high interest rate currency and deposits the funds in the low interest rate currency. S2: In a carry trade, the speculator’s expected profit decreases if the low interest rate currency appreciates against the high interest rate currency.
A. Both statements are correct
B. S1 is correct but S2 is false
C. Both statements are false
D. S2 is correct but S1 is false
THE CORRECT OPTION IS D.
BECAUSE, IN A CARRY TRADE, THE SPECULATOR BORROWS FROM LOW INTEREST RATE CURRENCY AND DEPOSITS THE FUNDS IN THE HIGH INTEREST RATE CURRENCY. PEOPLE GENERALLY WHERE COST IS LOWER AND INVEST WHERE THEY GET HIGHER AMOUNT. RATIONAL INVESTORS HAS A MENTALITY OF GIVING LESS AND GETTING MORE. THE SAME LOGIC APPLIES IN CARRY TRADE. HENCE, THE FIRST STATEMENT IS FALSE.
IN A CARRY TRADE, THE SPECULATOR'S PROFIT DECREASES IF THE LOW INTEREST RATE CURRENCY APPRECIATES AGAINST THE HIGH INTEREST RATE CURRENCY. IF A SPECULATOR WANTS PROFIT THEN HE WOULD EXPECT HIGH INTEREST RATE CURRENCY IN WHICH THEY DEPOSITED THE FUNDS TO APPRECIATE AND THE LOW INTEREST RATE CURRENCY FROM WHERE THEY BORROWED TO DEPRECIATE. IF THE HIGH RATE CURRENCY APPRECIATES THEN THE DEPOSITED FUNDS WILL INCREASE BY MORE AMOUNT AND THEY HAD TO REPAY LESS. AND THE REMAINING AMOUNT WILL BE THE SPECULATOR'S PROFIT. SO THE SECOND STATEMENT IS TRUE.
