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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: Mark Adams who wrote (41221)	11/11/2003 12:58:25 AM
From: macavity	Respond to of 74559

Put Call Parity. Effectively the Yield differential trade gives you an FX Forward. BORROW IN USD FOR 1 YEAR @ 1% DO SPOT FX INTO EURO @ 115 DEPOSIT INTO EUR FOR 1 YEAR @ 3% This is equivalent of buying a EURUSD forward at 115 x [1 + * (3%-1%)] = 117.30% in 1 years time. Voila! You have a 'synthetic' 1 year FX Forward [EUR/Long-USD/Short]. i.e. you are taking an FX bet that the EUR will appreciate. This is basic arbitrage pricing theory. Buying an option USD/Call-EUR/Put to protect against Dollar appreciation, converts the synthetic forward above into a synthetic option USD/Put-EUR/Call. This is put/call parity. i.e. you are still taking an FX bet that the EUR will appreciate. The reason why the Carry Trade 'sounds' more complicated is that usually the 'foreign' asset is not a bond/deposit but something with a bit more gas! Say a Euro stock. Where you make/lose money on carry trade. FX price change. Invested asset price change. -macavity