Carry Trade

Beginner Questions
1

Hello all! Long time user, first time post-er. Any FX veterans out there who can describe/define for me the setup and mechanics of a “carry trade?”

Thanks in advance!

Feelin it!

2

At it’s most basic, a carry trade is simply being long a relatively high interest rate currency and short a low interest rate one. Since you pay interest on your short currency position (because you borrowed it) and earn interest on your long currency position (because you deposited it) you make the difference.

A very basic carry trade would be to go long USD/JPY since the USD interest rate is several percentage points higher than the JPY one.

Of course, if the market moves against your position you could suffer losses that more than make up for your interest differential gains.

4

Here’s a good overview, http://www.babypips.com/school/the_carry_trade.html

5

Interestingly a month or so ago in wake of the carry trade stutter a few banks released studies on the carry trades and their profitability. Economic theory through interest rate parity suggests that in the long run spot rates should adjust to counter any carry benefits but this does not seem to prevail in the market. Most of the banks found that the carry trade would give you interest rate and capital profits.
Although there have been periods where carry trades have come off very very fast!!! Remember “the markets can remain irrational longer than you can stay solvent”. To ironically quote the greatest economist

6

can u tell me the name of this economist?
thanx.

7

John Maynard Keynes greatest economist and some say the first hedge fund manager… although he never had a fund apparently he used long short strats

8

Actually, it’s forward rates that adjust to account for interest rate differentials. That’s why you will see the spread between spot rates and futures rates vary over time (and of course with time to expiration).