The Carry Trade is a trading strategy where investors/traders sell or borrow assets (such as currencies) with lower yielding interest rate] 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 0.00% a year)and buy an equivalent amount of Australian Dollars (which yields 3.50% a year) simultaneously. So, for as long as you hold that position you would pay 0.00% interest a year for borrowing Japanese Yen, and receive 3.50% a year for holding Australian Dollars.
The interest rate differential of that position is +3.50 (3.50% – 0.00%). So you would receive approximately 3.50% a year on the value of the position, depending on the margin interest charged by the broker and on exchange rate volatility.« Back to Forexpedia Index