Measuring FX Carry Through Forward Contracts and Spot Resets
Summary
The document explains how to think about a rolling foreign exchange carry trade and why an implied yield is not itself the trade’s return. The forward rate embeds the interest differential under covered interest parity, which links spot, forward, and currency interest rates. A carry position seeks a realized exchange rate that moves less adversely than the forward pricing implies.
One approach is to enter a forward and hold it to maturity, then settle and reverse the currency exchange at the prevailing spot rate before opening the next forward. The discussion says performance can be assessed at each roll by comparing the agreed forward with spot at maturity; yields are already reflected in the forward price. It does not provide a full return formula or address trading costs, collateral, or other implementation details, and its statement that parity would eliminate gains assumes the parity relationship holds as described.
Key ideas
- Covered interest parity relates the forward exchange rate to spot and the interest rate differential.
- An implied currency yield is inferred from rates and FX prices, rather than serving directly as carry trade profit.
- A rolling carry position can be evaluated when each forward matures by comparing its contracted rate with spot.
- The trade seeks a realized currency move that is less adverse than the forward pricing implies.
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Full text
# FX carry trade and how to calculate it # FX carry trade and how to calculate it I am trying to calculate the FX carry on let's say USDILS for a task. I was given the 3M Forward Implied Yield (ILSI3M CMPN Curncy on Bloomberg) and I need to use this in order to calculate my FX carry on this pair. I have looked up the WCRS function on Bloomberg to see how they calculate it, however it does not feel right. What troubles me is that I don't know if I just take this rate, keep the trade for 3m and then roll it and keep it for another 3m and calculate the FX spot difference. Or if I have to roll the 3M Forward implied yield everyday during my time horizon (if so how do I calculate that?) of investment and at the end look at the FX spot difference as well. Or Am I completely wrong? ## Answer by AKdemy (score 2) https://quant.stackexchange.com/a/65411 Implied yield is only remotely related to carry trades. The help page actually explains how everything is computed. In this case it is simply using 3m libor, spot and the FX forward to back out the current implied ILS yield via covered interest parity which states that the exchange rate should exactly offset the interest rate differential. If this unbiasedness hypothesis holds, the carry trade will never make (or lose money). In terms of WCRS, you can see here how Bloomberg computes it. Generally it is like noob2 mentioned. You enter into a forward and hope the exchange rate doesn't change as much as covered interest parity suggests (or even worse). ## Answer by nbbo2 (score 2) https://quant.stackexchange.com/a/65413 The way FX Carry trade usually works is: you enter into an FX forward contract with 3m maturity today (at the current forward price) and you keep it for 3 months. At maturity there is an exchange of currencies as previously agreed, but you immediately reverse that with an opposite transaction in the FX spot market (there will be a profit or loss of course, the rate in the Spot market is not the same as the forward rate you agreed to 3 months ago), then you enter into a new FX forward for the next 3 months. (So to know how you are doing you only have to look at the Forward and Spot rates in Bloomberg every 3 months. You don't have to have data on yields in the two currencies, those are automatically taken into account in the forward price).
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