Educational Post

What Is a Carry Trade?

A carry trade is a strategy where you borrow money in a currency with low interest rates and invest it in a different currency or asset that offers higher returns. The idea is simple: you're looking to profit from the difference between these rates.

While this strategy is mostly used in the world of forex and currency trading, it can also be applied to stocks, bonds, and even commodities.

How Carry Trades Work

Here’s how it usually goes: you take out a loan in a currency that has low or near-zero interest rates – think the Japanese yen (JPY), which has had low rates for years. Then, you convert that money into a currency with a higher interest rate, like the US dollar. Once you have the higher-yielding currency, you invest it in something like US government bonds or other assets that give you a good return.

For example, if you borrow yen at 0% and invest it in something that pays 5.5%, you're earning that 5.5%, minus any fees or costs. It’s like turning cheap money into more money (as long as the exchange rates play nice).

Why Investors Use Carry Trades

Carry trades are popular because they offer a way to earn a steady return from the interest rate difference, without needing the value of the investment to go up. This makes it a favorite among big players like hedge funds and institutional investors, who have the tools and knowledge to manage the risks.

Often, investors use leverage in carry trades, which means they borrow a lot more money than they actually have. This can make the returns much bigger – but it also means the losses can be just as large if things don’t go as planned.