Monday, May 4, 2015

invest - high risk, high expected return - HY, currencies

In theory, high risk means high (expected, not historical) return. More specifically, if an asset is perceived as more risky, then investors would demand evidence that it would yield higher return.

Simplest example is the risky bond. Assuming zero coupons, both the junk bond and the gov bond has the same maturity value of $100. Junk bond is shown (Evidence!) to be more likely to default, so the current price is lower, leading to higher expected return. That's the basic idea of risk premium.

A 2nd example is FX carry trade, like long INR/JPY. INR is expected to depreciate so investors demand higher interest.

Long spot in Turkish TRY is another example. High risk high interest.

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New York (Time Square), NY, United States
http://www.linkedin.com/in/tanbin