What is: Carry Trade

What is Carry Trade?

Carry trade is a strategy used in the financial markets where an investor borrows money in a currency with low interest rates and invests it in a currency with higher interest rates. The goal of carry trade is to profit from the interest rate differential between the two currencies.

How does Carry Trade work?

In carry trade, investors typically borrow money in a currency with low interest rates, such as the Japanese yen, and invest it in a currency with higher interest rates, such as the Australian dollar. The investor earns the interest rate differential between the two currencies as profit.

Risks of Carry Trade

While carry trade can be profitable, it also comes with risks. One of the main risks of carry trade is exchange rate risk, as fluctuations in exchange rates can erode profits or even lead to losses for the investor.

Benefits of Carry Trade

Despite the risks, carry trade can be attractive to investors because of the potential for high returns. When executed correctly, carry trade can generate significant profits for investors.

Factors to consider in Carry Trade

When engaging in carry trade, investors should consider factors such as interest rate differentials, economic conditions, and geopolitical events that can impact exchange rates and the profitability of the trade.

Examples of Carry Trade

One example of carry trade is the popular “yen carry trade,” where investors borrow in Japanese yen and invest in higher-yielding currencies. Another example is the “commodity carry trade,” where investors borrow in low-interest rate currencies and invest in commodities.

Conclusion

Carry trade is a popular strategy in the financial markets that involves borrowing money in a currency with low interest rates and investing it in a currency with higher interest rates. While carry trade can be profitable, it also comes with risks that investors should be aware of.