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Carry Trade Explained

What is all this talk about the 'Carry Trade'? Everyone keeps on talking about it but what is it? What does it mean?

Well, it's not as complicated as one could think. Basically, the concept revolves around a play on currency yields. It consists in borrowing a low-yielding currency and investing the amount in a currency that is offering a higher yield; the yield difference representing your gain (minus tax and commissions).

An example of this could be to borrow 1,000 Yen and convert them into USD and then use them to by a USD denominated bond. Assuming that the bond pay 5% and that the Japanese interest rate is at 0,35%; you would stand to make a profit of 4,65% (as long as the exchange rate stays the same). Furthermore, using a common leverage of 10:1, this would mean that you would stand to make a profit of 46,5%!

Easy money? Well, we should all know that potential returns are always related to the amount of risk you are taking on. If you decide to execute this kind of trade, then it means that you are makanig a bet on the exchange rate direction but please remember that depending on the amount of leverage you decide to use, gains AND losses can be very substantial.

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