Q. Among the carry trades available in the US, Euro, and UK markets, the highest expected return for the USD-denominated portfolio over the next 6 months is closest to:
- 0.275%.
- 0.85%.
- 0.90%.
B is correct. The highest potential return, 0.85%, reflects borrowing USD for 6 months and buying the UK 5-year bond. The carry component of the expected return is actually a loss of 0.15% [= (1.10% – 1.40%)/2], but this is more than offset by the 1% expected appreciation of GBP versus USD. A much higher carry component +0.90% = (1.95% – 0.15%)/2 could be obtained by borrowing for 6 months in EUR to buy the US 5-year note, but that advantage would be more than offset by the expected 1% loss from depreciation of the USD (long) against the Euro (short).
