At the heart of the JPMorgan's $2 billion whale of a trading loss was a deeply flawed belief.
Fortune -- If you want to understand the ill-fated trade that has cost JPMorgan Chase (JPM) nearly $2.5 billion and counting, all you really need to understand are three words: Negative carry trade. And what you need to understand about those three words is that they are dirty - really, really dirty.
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In general, Wall Street hates negative carry trades. But it's likely that no where were negative carry trades more loathed than at JPMorgan Chase. Ina Drew, the firm's former chief investment officer, who resign on Monday amid the trading scandal, reportedly believed that the bank could hedge against business losses and still make money at the same time. That's very hard to do in general. But it's impossible to do with a negative carry trade. That's because, until they payout, which not all do, negative carry trades cost more and more money the longer you hold them.
Most negative carry trades involve buying insurance and paying a regular premium. But they don't have to. If you rent, because you believe housing prices are going to drop and that you will be able to buy a home cheaper later, in Wall Street speak that's a negative carry trade. The rent you shell out each month, minus what you would have paid in interest (after-taxes) on your mortgage and property taxes, is your negative carry. And the longer you rent, the more housing prices have to drop to make your choice to wait pay off.
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