Bites Of Trading Knowledge #15

What is an Interest Rate Differential? -

An interest rate differential is a change in the interest rates between the currencies of two countries. It is a measure of how money from two countries compares to each other.

What is the Carry Trade? -

The carry trade is where an investor borrows in a currency where the interest rate is low and converts those funds into a currency where the interest rate is higher.

For example, if one currency has an interest rate of 5% and the other has a rate of 1%, it has a 4% interest rate differential. If you were to buy the currency that pays 5% against one that pays 1%, you would be paid on the difference with daily interest payments.

Common application of financial market instruments for managing risk and opportunities.

Diversification: Portfolio Risk Using FX Futures

Portfolio diversification is the process of investing your money in different asset classes and securities in order to minimize the overall risk of the portfolio.

For both corporate and individual investors, having access to markets that enable the building of a diversified portfolio is an important consideration when managing futures focused accounts.

Similar to managing risk, the market to trade would be a key variable to clearly state and support with reasons for trading or investing. Reasons for selecting one market over another could include price volatility, liquidity, daily volume traded, size of the minimum price increment, and value of the minimum price increment. Comparing these variables between markets will help decide the suitability and/or risk of each.

For example, the parameters for a price driven strategy may be designed to be applied to any market whether it be index equity futures or forex futures. However, the signals for entry may not always trigger if a trader were just to focus on a single index equity futures. Having access to markets such as the Micro MSCI USA Index futures could add diversification to a portfolio in an efficient manner.

Having access to other futures markets to apply the strategy to allow for the creation of a diversified portfolio with varying entry and exit points or the ability for more trading oriented investors increased opportunities to execute price driven strategies more often across a range of futures markets.

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TRADDICTIV · Research Team

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