| Defined as the "borrowing of one low yielding | | | | traders also benefiting from the shift in price. This |
| currency, and investing in a higher yielding pair", the | | | | however can work in both ways, with movements |
| carry trade allows investors to play the interest rate | | | | exacerbated during economic devaluation or |
| differential between two economies. An example of | | | | weakness. |
| the carry trade in its purest form was the dollar yen | | | | Risks |
| prior to the global financial crisis. Traders focused on | | | | The risks associated with the CT can be quite |
| extracting the monetary yield, between the US and | | | | significant. The recent global financial crisis is an |
| Japan at the time. Although the C Trade has become | | | | example of the dangers of the carry trade with the |
| an attractive option for many investors and traders, | | | | drop in US monetary policy pushing the yield margin |
| there are a number of key risks which must be | | | | between the greenback and its currency |
| observed. The benefits and risks associated are | | | | counterparts to record low levels. Economists have |
| highlighted in the below section. | | | | noted that the prominent US Dollar Japanese Yen |
| Benefits | | | | carry trade no longer exists due to the economic |
| As discussed in the previous paragraph, the c trade | | | | environment. Some blame this for the recent |
| has grown in interest over the last decade due to | | | | appreciation in the Yen against the greenback. The |
| fluctuating world monetary policy. The key benefits | | | | key risks of the carry trade include: |
| of the CT include | | | | • Interest Rate Policy shift - Weakening of |
| • Cheaper Borrowing costs - sourcing currency | | | | monetary policy due to economic concerns can lower |
| from low yield economies | | | | the yield return without lowering the overall risk. |
| • Flexibility of Investment Yield Choice - investors | | | | • Price movement adversity - Traders can lose |
| are able to look at investing the borrowed currency | | | | on the carry trade if the price goes against them. |
| in a range of higher interest rate currencies | | | | The yield in many cases can then not cover the |
| • Ability to leverage on borrowings - Investors | | | | overall lose in the price shift. |
| can leverage with foreign exchange and hence are | | | | • Government intervention - Central Banks can |
| able to borrow more currency at a lower interest | | | | intervene from a liquidity point of view in the |
| rate and invest or lend at a higher rate. | | | | currency markets. This can have a dramatic impact |
| The benefits of the carry trade also extend to | | | | on price and sentiment. The carry trade's |
| market movements and positive fluctuations. As | | | | attractiveness can change dramatically impacting the |
| more interest in the C Trade for a specific currency | | | | risk of the trade. |
| grows, the more inflated the price can become, with | | | | |