Question

You are looking at the markets for THB (Thai bahts) and EUR. You observe that the bid/ask interest rates in Thailand are 20%/22%, and the bid/ask interest rates on the euro are 2%/4%. The spot exchange rate is 40.9 THB/EUR, and you expect that in the next 3 months (90 days) the exchange rate will not move much, moving to 42.1 THB/EUR.

Your borrowing capacity is 2 million EUR and 50 million THB.

Based on this information, you decide to borrow EUR at the relatively low rates, and invest in the higher THB rate. What will be your profit as measured in EUR?

Answer 1

A) The above question is an example of a carry trade. We borrow in lower interest rate and invest in higher interest rates to get profits.

Here we borrow EUR at interest rate of 4 percent

Borrow 2 million EUR AT 4 PERCENT that is 2000000*1.04 which equals 2,080,000 EUR

Take loan of 2,080,000 EUR

Now convert 2 Million EUR to THB at 40.9 THB/EUR that equals to 2000000/40.9 THB which equals to

48,899.75 THB

Now invest this THB at 20 percent interest rate (At BID rate in Thailand)

48 ,899.75*1.2 (1.2 here is 20 percent interest rate)that is 58,679.7 THB

After 3 months convert THB to EUR at 42.1 THB/EUR

58,679.7*42.1 EUR

which equals 2470415.37 EUR

Now repay the loan of 2,080,000 EUR

Profit is 2470415.37 EUR-2,080,000 EUR

which equals 390,415.37 EUR

So by using carry trade we get profit of 390,415.37 EUR (In 3 months as given in the question)