The Aim of Carry Trade

Decent Essays

We first illustrate the concept of “Carry Trade”. It is the process whereby an investor borrows money from a low-interest country, uses the fund by converting (i.e. selling) it to a different currency yielding a higher interest rate. The aim of carry trade is to profit from the interest rate differential between the 2 countries involved. Huge profits as well as substantial lost are most of the time the likely benefit and downside risk respectively. First thing to look for when starting a carry trade is to look for the two currencies offering a high and low interest yield.

Amount of Leverage used is of major concern when carrying out this particular type of trade

• Carry Trade will bring profits when:
i) Interest Rate is increased by Central Bank ii) The Environment offers low volatility

• Carry Trade might causes losses when:
i) Interest Rate is brought down by the Central Bank ii) Intervention on the Exchange Rate by the Central Bank

To illustrate what ‘Carry Trade’ is, we will look at an AUD-JPY example.
Suppose the interest rate of:
• AUD is 6% &
• JPY is 1%
First thing we look at is the interest rate differential which is quite considerable (5%)
We first borrow JPY then we use the funds to buy AUD
We will then be entitled to receiving a 6% interest rate on AUD and will be paying an interest rate of 1% on JPY both per year entitling us to a profit of 5%.
Thus the aim always is to always buy the currency with the higher interest rate and sell the one with the lower

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