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3. Adventures in the Carry Trade. Working for a major hedge fund, you are in charge 80+20 of FX-trading strategies specializing in carry trades, which have become much harder to implement and do not yield the same returns as 10 years ago. With hindsight, the European debt crisis was a watershed moment for this and related strategies. As a result, you and your company are rethinking their approach to foreign-currency invest- ments and speculation. You have come across a recent publication by John Bilson for the Chicago Mercantile Exchange on carry trades, which is proving very helpful in your reassess- ment of carry trades and their future. 1 (a) Describe the mechanics of the carry trade and sort the data in Table 1 into borrowing, investing, and intermediate (neither-nor) currencies. (b) What is the crucial risk in carry trades and which are its three most common sources? How would you address each source of risk in your carry-trade strategy? (c) Using the data in Table 1 and IRP with transaction costs (see textbook), compute break- even FX rates for one-year carry trades funded in the JPY and EUR and present your findings in tabular form. You might want to carefully study the INR example given in the article to properly identify bid or ask rates for the various transactions and, hence, calculations involved. (d) Explain how one can implement carry trades with futures or forward contracts. Once again, you might want to use IRP. How do futures and forward contracts differ? What would you simply do to implement a carry trade with futures or forward contracts? Why do carry trades with futures and forwards need to yield the same (positive or negative) return? What does the return expression for the futures-contract implementation show about carry trades? 3. Adventures in the Carry Trade. Working for a major hedge fund, you are in charge 80+20 of FX-trading strategies specializing in carry trades, which have become much harder to implement and do not yield the same returns as 10 years ago. With hindsight, the European debt crisis was a watershed moment for this and related strategies. As a result, you and your company are rethinking their approach to foreign-currency invest- ments and speculation. You have come across a recent publication by John Bilson for the Chicago Mercantile Exchange on carry trades, which is proving very helpful in your reassess- ment of carry trades and their future. 1 (a) Describe the mechanics of the carry trade and sort the data in Table 1 into borrowing, investing, and intermediate (neither-nor) currencies. (b) What is the crucial risk in carry trades and which are its three most common sources? How would you address each source of risk in your carry-trade strategy? (c) Using the data in Table 1 and IRP with transaction costs (see textbook), compute break- even FX rates for one-year carry trades funded in the JPY and EUR and present your findings in tabular form. You might want to carefully study the INR example given in the article to properly identify bid or ask rates for the various transactions and, hence, calculations involved. (d) Explain how one can implement carry trades with futures or forward contracts. Once again, you might want to use IRP. How do futures and forward contracts differ? What would you simply do to implement a carry trade with futures or forward contracts? Why do carry trades with futures and forwards need to yield the same (positive or negative) return? What does the return expression for the futures-contract implementation show about carry trades

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