Book SummaryThe Rise of Carry, by Tim Lee, Jamie Lee, and Kevin Coldiron

1-Page Summary1-Page Book Summary of The Rise of Carry

The operational details and the nature of transactions that employ borrowing in the realm of currency, including those linked to foreign exchange.

The book delves into the fundamental strategies of trading that leverage differences in interest rates, highlighting their essential features and offering illustrations, with a particular focus on the currency exchange market. The authors emphasize the distinctive characteristics of carry trades, which distinguish them from traditional investment strategies: they involve the use of leveraged funds, act as providers of market liquidity, and generate returns through speculation on the consistency of market fluctuations.

Carry trades often display a return profile resembling a "sawtooth," with gradual, consistent profits periodically offset by substantial setbacks, typically involving the use of borrowed funds to provide capital.

Carry trading activities have the potential to engage with a variety of markets and financial sectors. The authors argue that, although complex, these occurrences always manifest four distinct traits: they involve leveraging to increase financial risk, providing the market with liquidity or assets, typically yielding returns in stable conditions but facing considerable losses when markets are volatile, and a return profile characterized by frequent small profits punctuated by occasional large losses. Financial markets have undergone a significant transformation in recent years due to the growing prevalence of carry trading.

Investors frequently participate in trades where they borrow from assets or currencies with low yields to invest in those offering higher returns, capitalizing on the disparity in interest rates.

Every transaction known as a carry trade involves the use of borrowed funds. They participate in transactions that may include direct financial leverage, such as obtaining a loan against securities to purchase equities, or entail a risk where possible losses could exceed the original investment. The strategy involves borrowing funds in a currency that has lower interest rates and then investing in assets denominated in a currency with higher returns. A trader employs a technique of obtaining loans in currencies known for their lower interest rates, such as the US dollar or Japanese yen, and then channels these funds into currencies that yield higher interest, such as the Turkish lira. They generate revenue through the difference in interest rates. Investors run the risk that the currency they invest in may depreciate against the currency they financed with, potentially offsetting the benefits gained from the differential in interest rates.

The authors observe that there is no single, widely accepted description for the execution of a currency carry trade. A hedge fund might illustrate this principle through the acquisition of bonds denominated in Turkish lira, financed by loans taken out in dollars. What occurs if a Brazilian firm decides to finance a domestic investment by obtaining a loan that is valued in US dollars? Can a Japanese investor employ private capital to acquire US Treasuries, which offer higher yields than bonds from the Japanese government? The authors infer that transactions involving leveraged funds fall under the category of currency carry trade activities. A Brazilian company investing in a domestic project does so knowing that possible changes in the value of the Real relative to the US dollar will not outweigh the benefits of securing loans in US dollars at reduced interest rates. The Japanese investor acquiring US government bonds is not engaging in the typical strategy of leveraging low interest rates to seek out assets with higher returns, since she is not employing leveraged capital to enhance potential gains.

Participants in carry trading enhance market fluidity by taking on risks in anticipation of a return that includes a premium.

The authors argue that, typically, carry trades are anticipated to produce positive results as time progresses. This concept can be understood through a multitude of approaches. Carry trades consistently yield profits in stable markets by inherently taking advantage of situations where there is an absence of volatility. Investment strategies that thrive in periods of low market fluctuations generally produce smaller gains compared to those that benefit from increased market instability, since most investors prefer methods that generate favorable results in times of economic decline.

Carry trades are anticipated to yield positive returns over time as a reward for supplying liquidity. A currency carry trader engaging in the exchange of borrowed dollars for Turkish liras essentially supplies dollars to sellers and liras to purchasers. The authors stress that the act of supplying market liquidity extends beyond mere involvement in currency carry trades. In the stock market, those who primarily deal in options trading or volatility futures transactions are known as market makers. During stock market downturns, traders who utilize leveraged capital and are subject to demands for additional collateral often find their actions balanced by others who opt to sell volatility and buy stocks. Their compensation can be partially regarded as a reward for improving market fluidity.

Engaging in carry trades often results in consistent, small gains, but these can be wiped out by substantial losses during periods of increased market volatility and uncertainty.

Carry trades typically experience losses in times of extreme market volatility, leading to their association with taking a position against volatility. The pattern of returns is akin to a sawtooth, yielding regular, modest gains similar to the consistent income of an insurance company, punctuated by abrupt, substantial losses akin to the claims an insurer settles following a catastrophe. They gain slowly and give back quickly. These transactions also inherently include elements...

The Rise of Carry Summary The Carry Trade has evolved and expanded significantly, largely due to the critical role financial institutions play in the valuation of volatility.

This part examines how the financial objectives and balance sheet declarations of financial entities are crucial in expanding the range of carry trade operations. Sovereign wealth funds have emerged as major players with considerable clout in global affairs. The expansion of this trend has occurred in parallel with the broadening influence of the Carry Regime, positioning them optimally for participation in carry trading due to their financial commitments and motivational frameworks. The authors analyze the changing dynamics of market volatility, with a specific focus on the S&P 500, highlighting a prevailing trend that favors investors who wager on consistency. The writers argue that the S&P 500 has become a crucial part of the worldwide carry trade, with its fluctuations now being the main risk factor for markets globally.

Hedge funds are particularly adept at facilitating carry trades, owing to their use of leveraged funds and the way their compensation models are designed.

Hedge funds typically operate with a lack of openness, employing a diverse range of tactics throughout multiple markets and leveraging borrowed funds. The characterization is largely precise. Coldiron...

The Rise of Carry Summary The way the carry regime shapes central bank policies, plays a role in the formation of economic bubbles, and impacts macroeconomic outcomes.

The concluding part of the discussion delves into the manner in which the prevailing global carry regime has become a defining force in the contemporary business cycle, ultimately leading to a situation where both economic expansion and interest rates are trending towards a null point. The prevailing perspective, which once considered the manipulation of interest rates to be the primary force behind the growth of credit and the oscillations in the business cycle, is now regarded as outdated. Carry trades, which often grow due to the actions of central banks, generally lead to considerable early gains but also pave the way for the formation of large market bubbles and their subsequent collapse.

The carry regime often results in a downward pressure on prices, which in turn causes a reduction in interest rates, an increase in borrowing, and a deceleration of economic growth.

The writers argue that worldwide economies and financial markets are now primarily driven and significantly influenced by the concept of carry. The writers argue that the prevalent engagement in carry trades encourages deflation by fostering too much debt and mispricing risk, thereby obstructing authentic...

The Rise of Carry Summary The broader implications of the carry trade dynamic extend to matters of wealth disparity, shifts in power dynamics, and embedded dangers.

The authors explore the broader consequences of the carry regime, recognizing that its influence goes beyond a simple financial concept and encapsulates the power dynamics present in social exchanges. The authors argue that the carry regime's intrinsic instability exacerbates economic stagnation and amplifies the growing disparity in the distribution of wealth. Central banks have unintentionally trapped themselves by their own actions of intervention.

The regime of carry intensifies the accumulation of wealth and power among capital providers and individuals who facilitate the smooth operation of markets.

The authors emphasize that the current carry system exacerbates imbalances and consolidates power within organizations that provide crucial liquidity or leverage to the economy and financial markets.

Engaging in carry trades can amplify situations where small initial advantages may balloon into substantial imbalances.

Chapter 11 characterizes carry as a mechanism that inadvertently redistributes wealth from those burdened with debt or seeking liquidity towards organizations with the fiscal robustness and excess capital to be selective in their investment choices....