What is Carry Trade (in detail)?

In essence, Carry Trade consists of:

Borrowing in a currency with a low interest rate and investing in a currency with a higher interest rate, profiting from that difference (the "carry").

📌 How does it work in practice?

Choosing the currencies:

You borrow money in a country with a low interest rate (like Japan or Switzerland).

You convert that money into a currency of a country with a high interest rate (like Brazil or Mexico).

You invest that amount in assets denominated in that currency (like government bonds or bank deposits).

Earning from the interest rate differential:

If the interest in Japan is 0.5% per year and in Brazil is 10% per year, you theoretically profit 9.5% per year, minus costs and risks.

Simplified practical example:

You borrow ¥100 million in Japan at 0.5% per year.

You convert it to R$4 million and invest in Brazilian bonds yielding 10% per year.

At the end of the year, you will have a gross return of 10% in reais, pay 0.5% interest in Japan, and if the exchange rate does not move against you, you pocket the differential (carry).

🔁 Carry Trade in the Forex market

The strategy is often done with currency pairs. Classic example:

Buy AUD/JPY (Australian dollar against Japanese yen):

The Australian dollar usually has higher interest rates.

The Japanese yen tends to have low or negative interest rates.

You buy AUD (high rate) and sell JPY (low rate).

🧠 Why does Carry Trade work (when it works)?

In times of global financial stability, carry trade tends to work well, as there is a risk appetite.

In times of crises or uncertainties, the strategy often fails, as capital flows reverse and cause strong currency movements.

📊 Real historical example

Before the 2008 crisis, many investors were doing carry trade with JPY (Japanese yen) and NZD (New Zealand dollar).

When the crisis hit, there was a strong appreciation of the yen (funding currency), causing significant losses for those exposed in that operation #BinanceAlphaAlert