I’m a little confused on how the CFAI books describe and calc FX carry trades. On the blue box example on page 525, question 5, they ask for the return in JPY terms. In this example, they place the ‘today’ spot rate in the denominator. If you go to the EOC questions (question 3), they also ask for an FX carry trade return, but in this example, they place the 1 year spot rate in the denominator. What gives with this logic?
Also, in the EOC question, they multiply the investment rate against the current spot rate, but in the blue box example, they multiply it against the one year spot rate. Why?
Maybe I’m just overlooking someting here, but I don’t feel like the text explained the methodology here very well. I’ve always looked at returns in the "new price over old price’ approach. I would think that by short one currency, I would be investing/going long the other currency at the current spot, so return there would be ((1+rate)*current spot). Then, after the investment horizon, I would take my yield, convert back to the short currency at the one year rate (which would also be the current spot at that time), and pay my loan back and deduct borrowing cost.
Anyway, does anyone have a good way/formula for explaining this?