In the context of foreign exchange, Carry Trade means holding a currency with a higher interest rate against a currency with a lower interest rate. The main objective is to profit from the interest rate differential.
For example, an investor borrows Japanese Yen at a low interest rate of <1%, converts the Japanese Yen to Australian dollars and uses the Australian dollars to buy Australian bonds with a yield of 3.5%. The investor is able to use part of the return from the bonds to repay the interest of the loan and still keep some as profits.
The only risk in the above example is when the Japanese Yen strengthens against the Australian dollar. This means the investor needs more Australian dollars to be converted back to Japanese Yen in order to repay the interest and also the principle amount of the loan.
The investor could be making a loss as a result of this.
Because the Japanese Yen traditionally has low interest rates, the term “Yen Carry Trade” has become fairly popular.
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