From Reading 13, Example 13:
I am not following the last sentence in the solution. Why is the carry difference between foreign currency floating rates and domestic currency floating rates highest in an upward sloping domestic yield curve?
Thanks!
Because you borrow at the short end of the curve. If your domestic yield curve is upward sloping, then you maximize the spread between your lending and borrowing rates.
Because as the yield curve is upward sloping the rates at the lower end of the curve will be less and therefore you will execute a trade by buying at the very low end and investing at the higher end in the foreign currency.
I understand that because the foreign short term rate is higher than domestic short term rate, so you borrow in domestic and receive foreign. But what exactly determines fixed vs. float?
Still not clear on this. I understand that because the foreign short term rate is higher than domestic short term rate, so you borrow in domestic and receive foreign. But what exactly determines fixed vs. float?
With a stable, upward-sloping domestic yield curve, would you rather pay fixed or pay floating?
As for the foreign yield curve, truth be told, there’s not enough information to say categorically that you would prefer to receive floating than to receive fixed (or vice versa).
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Thank you for asking me the right question as usual. I guess I would pick floating because as the loan term nears maturity the rate would fall.
I thought about the foreign curve some more and I believe this might be a simple matter of whether we want positive duration or negative duration when rates are expected to rise. Receiving float would give the negative duration we need when rates are expected to rise.
I was thinking about it from a cash flow perspective. Will the short-term rate rise enough to surpass the fixed rate? I, for one, don’t know.
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