Negative Carry Pair

What Is a Negative Carry Pair?

A negative carry pair is the foundation of the negative carry trade. A negative carry pair is a foreign exchange (forex) trading strategy in which the trader gets money in an exorbitant interest currency and invests it in a low-interest currency.

A trader would possibly start this strategy assuming they were bullish on the low-interest rate currency, accepting that it will appreciate relative to the exorbitant interest rate currency. This is on the grounds that the net amount of interest they need to pay to keep up with the position surpasses their interest income, making it costly to carry. In that capacity, it is something contrary to the undeniably more famous positive carry pair, which forms the basis of the carry trade.

Understanding Negative Carry Pairs

The negative carry pair is a forex trading strategy that looks to take advantage of differences in the exchange rate and interest rates associated with various currencies, where it is successfully the reverse of the more well known carry trade strategy.

To start a negative carry pair, the trader gets money in a currency in which interest rates are higher, and afterward invests those proceeds in one more currency with lower interest rates. This means that, after starting the position, the trader will really bring about negative net cash flows in light of the fact that their interest expenses on the short currency surpass their interest income on the long side. Conversely, the traditional carry trade includes taking the contrary position: borrowing in the low-interest currency and investing in the exorbitant interest one, to generate positive net cash flow on the very beginning.

A trader would possibly start the negative carry trade on the off chance that they accepted that the low-interest currency in which they are investing will see the value in relative to the exorbitant interest currency in which they are borrowing. In that scenario, the trader would profit when they reverse out of the initial trade: selling the currency they invested in exchange for the currency they borrowed in, then, at that point, repaying their debt and taking the gain on the transaction. Of course, this potential gain would have to surpass the cost of the interest payments made all through the term of the investment for the whole transaction to be a triumph.

Real World Example of a Negative Carry Pair

To illustrate, assume you are a forex trader keeping a close eye on the global currency market. You see that there is a 1:1 exchange rate between Country X and Country Y, and that interest rates in Country X are 4%, compared to 8% in Country Y. You additionally accept that Xs, the currency of Country X, will probably see the value in relative to Ys, the currency of Country Y.

Considering this, you choose to structure a position by which you can profit from the anticipated appreciation of Xs relative to Ys. To achieve this, you start by borrowing 100,000 Ys. Since their interest rate is 8%, you want to pay 8,000 Ys each year in interest.

Your next step is to invest this money in Xs. Since they have a 1:1 exchange rate, you sell 100,000 Ys and get 100,000 Xs. Since the interest rate on Xs is 4%, you receive 4,000 Xs each year in interest. Thusly, your net cashflow position after starting the trade is - 4,000 Ys each year (4,000 Xs Interest Income - 8,000 Ys Interest Expense, expecting a 1:1 exchange rate).

Throughout the next year, your prediction works out as expected and the X values by half relative to the Y. Consequently, you are able to sell your 100,000 Xs in exchange for 150,000 Ys. You then repay your loan of 100,000 Ys. In the wake of deducting your net interest expense of 4,000 Ys, you are left with a profit of 46,000 Ys on the transaction (150,000 Ys - 100,000 Y Loan - 4,000 Y Net Interest Expense).

Of course, in the event that the X had not valued relative to the Y, then, at that point, you would have lost to some extent however much your net interest expense. On the off chance that the X had rather depreciated relative to the Y, your losses might have climbed fundamentally higher.

Features

• Negative carry pairs bring about negative net cash flows, making them relatively costly to keep up with over the long haul.
• A negative carry pair is the basis for forex transactions including speculation on the appreciation of an exorbitant interest-bearing currency.
• It is the contrary position of the undeniably more famous positive carry trade strategy.