Interest Rate Differentials & Currency Carry Dynamics.
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What is covered in this chapter
The Engine of Capital Flows
Currencies do not exist in a vacuum. They are traded in pairs, representing a relative exchange rate. The primary force driving the exchange rate between two currencies is the interest rate differential—the difference between the interest rates of the base currency and the quote currency.
The Impact on Spreads and Swap
Interest rate differentials dictate the daily swap charges (overnight financing fees) on your trading account. If you hold a long position on a pair where the base currency has a significantly higher rate than the quote currency, you earn positive interest daily. Conversely, if you hold a short position, you pay the interest differential.
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