“A fixed-income manager is considering a foreign currency fixed-income investment in a relatively high-yielding market, where she expects bear flattening to occur in the near future and her lower-yielding domestic yield curve to remain stable and upward-sloping. Under this scenario, which of the following strategies will generate the largest carry benefit if her interest rate view is realized?”
a) Receive-fixed in foreign currency, pay-fixed in domestic currency
b) Receive-fixed in foreign currency, pay-floating in domestic currency
c) Receive-floating in foreign currency, pay-floating in domestic currency
Answer is C. I understand why you’d want to receive floating in foreign currency, but why would you want to pay-floating in domestic, versus paying fixed? ( I know it’s not a listed option - just trying to understand) Thank you
effect of carry trades on short term rates is negligible or less pronounced as compared to effect on longer term rates. the question also says and her “lower-yielding domestic yield curve to remain stable and upward-sloping” so rates are likely to remain stable at the short end of the YC. so it wouldnt really make much of a big difference whether she pays floating vs fixed at the short end of the YC.
The foreign currency market she expects bear flattening at the long end of the curve so effect of carry obviously will be more pronounced and she wouldnt want to get caught receiving fixed