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.
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 Glossary Index