Carry trade
1. Speculation - foreign currency.
A carry trade is a speculative foreign exchange trading strategy.
It involves borrowing a low interest-rate currency, and investing in a higher interest-rate currency.
The potential benefit to the trader is the interest differential between the higher interest income receivable on their investment, and the lower interest expense payable on their borrowing.
The downside is the loss on the likely depreciation of the higher interest-rate currency invested in.
The depreciation is explained by the International Fisher Effect.
The losses on the currency depreciation can exceed the interest rate gains by many times.
For this reason, it is a very high-risk form of speculation.
The trader hopes that they will be able to enjoy gains on the interest rate differential and then close out the trade, before any sharp weakening of the higher interest rate currency.
2. Speculation - other financial assets.
Similar speculative activity, where the financial asset invested in is any asset that produces a higher income than the cost of borrowing.
For example, riding the yield curve.
See also
- Arbitrage
- Cost of carry
- Day trading
- Depreciation
- Expectations theory
- Financial asset
- Fisher Effect
- Foreign currency
- Futures
- FX instrument
- Hedging
- Interest rate parity
- International Fisher Effect
- No arbitrage conditions
- Purchasing power parity
- Riding the yield curve
- Risk management
- Speculation
- Straddle
