A carry trade is an investment strategy that involves borrowing money in a currency with a low interest rate and investing that money in a currency with a higher interest rate. The goal of the carry trade is to earn the difference in interest rates between the two currencies, known as the "carry" or "carry return."
For example, a trader might borrow Japanese yen at a low interest rate and invest the proceeds in Australian dollars, which have a higher interest rate. The trader would earn the difference in interest rates between the two currencies as profit. However, this strategy involves currency risk, as exchange rate fluctuations can erode or even eliminate the profits earned from the carry trade.
Carry trades are typically executed in the foreign exchange market, where traders can easily borrow and lend different currencies. They are most popular during periods of low volatility and stable interest rates, as the returns from the carry trade can be predictable and relatively low-risk. However, carry trades can also be risky, as unexpected events or changes in interest rates can quickly turn a profitable trade into a loss.
Carry trades are generally leveragables.
Let’s say you go to a bank and borrow $10,000.
Their lending fee is 1% of the $10,000 every year.
With that borrowed money, you turn around and purchase a $10,000 bond that pays 5% a year.
What’s your profit?
It’s 4% a year! The difference between interest rates!
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