CARRY TRADE
Back to GlossaryDefinition
A strategy of borrowing in a low-yield currency to invest in a higher-yield currency.
Summary
A carry trade is an investment strategy where traders borrow money in a currency with low interest rates and use those funds to invest in a currency or assets that offer higher interest rates. The goal is to profit from the difference between the borrowing cost and the investment return, known as the 'carry.' This strategy works best when exchange rates remain stable or move favorably, but it carries significant risk if the borrowed currency strengthens against the investment currency.
Usage Context
Essential when studying international finance, foreign exchange markets, investment strategies, and understanding how interest rate differentials drive capital flows between countries. Critical for analyzing currency market dynamics and central bank policy impacts.
Common Confusions
- Thinking carry trades are risk-free because of interest rate differences
- Confusing carry trades with simple currency exchange
- Not understanding that exchange rate movements can wipe out interest gains
- Believing carry trades always involve physical currency borrowing
- Misunderstanding the role of leverage in amplifying both gains and losses
