Carry trade

From Forexpedia

The Carry Trade is a trading strategy where investors/traders sell or borrow assets (such as currencies) with lower yielding interest rates to fund or buy higher yielding assets.

In the Foreign exchange, interest is debited or credit from a trader's account everyday on open positions.

The most popular Carry Trade in recent history has been to sell Japanese Yen and buy higher yielding currencies such as the Australian Dollar , New Zealand Dollar , and British Pound.

For example, if you buy the AUD/JPY, then you sell Japanese Yen (which yields 0.50% a year)and buy an equivalent amount of Australian Dollars (which yields 6.50% a year)simultaneously. So, for as long as you hold that position you would pay 0.50% interest a year for borrowing Japanese Yen, and receive 6.50% a year for holding Australian Dollars.

The interest differential of that position is +6.00% (6.50% - 0.50%). So you would receive approximately 6.00% a year on the value of the position, depending on exchange rate volatility.