Financial bicycle – What is it, definition and concept

The financial bicycle is an investment method by which financing is obtained in one currency, and then said capital is changed to another currency with which an investment is made. The idea is to obtain profits from the interest rate differential between different currencies.

That is, through the financial bicycle, the investor acquires financing in one currency, and with that money buys and invests in an asset denominated in another currency.

The investor seeks to take advantage of the fact that the interest rate of the acquired loan is lower than the yield offered by the investment made.

For example, suppose that the investor acquires a financing of 20,000 dollars at an interest rate of 1% per year. Then, he buys pesos (from some Latin country) at an exchange rate of 2.5 pesos per dollar, for which he acquires 50,000 pesos and these are invested in a bond that offers a 10% return in annual terms. This would be a case of financial cycling.

Advantages and disadvantages of the financial bicycle

The main advantage of the financial bicycle is perhaps that it offers profits only from the interest rate differential between different currencies. In addition, it is not necessary to wait for a medium or long term to obtain a return.

However, there is a key variable in this whole story that we have not gone into detail about: The exchange rate.

What would happen if, after the investment period, the currency in which it was invested devalued? Well, they could even generate losses.

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Better explain with an example. Let’s return to the case of dollars and pesos that we mentioned previously. We said that the exchange rate was 2.5 pesos per dollar. This, at the beginning of the investment, which we will say was in August 2021. Now, suppose that the investor, after a year, in August 2022, obtains the return on the bond from him:

50,000*1.1=55,000 (principal plus 10% interest)

However, let’s imagine that the peso has lost value against the dollar during the investment period, and the exchange rate in August 2022 is 3.2 pesos per dollar. Therefore, when changing the capital from pesos to dollars, we will have:

55,000/3.2=17,187.5

That is, adding the initial capital plus what was earned with the investment, we accumulate a total of 55,000 pesos, but these are worth 17,187.5 dollars. This is less than the financing purchased, $20,000. Even for the credit received, interest of 200 dollars (20,000 * 1% interest) would have to be paid. In short, the investor has lost.

In conclusion, the financial bicycle generates profits as long as the currency in which it is invested does not devalue (or does not devalue as much) against the currency in which the investor borrowed.

The Argentine case

A well-known case of a financial bicycle was that of Argentina, for example, around 2017, when the Central Bank Bills (LEBAC), debt instruments issued by the Central Bank of the Argentine Republic, offered high yields in Argentine pesos, more than 20% per year. This was with the aim of attracting investments in pesos.

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However, the high interest rates in pesos had a cost, since they harmed, for example, those who wanted to borrow in the Argentine currency, with probable effects such as a slowdown in consumption.

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