Carry Trade

 “Carry Trade”

 A carry trade is the purchase of an asset that pays a high interest rate financed by borrowing money at a lower interest rate. In currencies, it means buying a high-yielding currency against a low-yielding currency (such as buying the Turkish lira, TRY, which yields 11.5% a year and selling the Swiss Franc, CHF, which has a negative yield of -0.05% a year).
 Carry trades are widely used in the FX markets, but they are not risk-free.
“The cost of carry,” or just “carry,” is what you pay to buy and hold an asset with borrowed money. You are in effect “carrying” the asset through time.
For example, let’s say you buy a house for $100,000 with the idea of renting it out for five years and then selling it. You take out a mortgage at 5% and pay $5,000 a year in interest. (This is a simplified example.) You rent out the house for $300 a month, or $3,600 a year. That means your net cost of financing the house (interest paid – interest received) is $1,400 a year, which is 1.4% of your investment of $100,000. So your cost of carry is 1.4%. A trade like this is said to have negative carry. That means it costs you money to carry the trade. Of course, if the price of the house goes up more than 1.4% a year, you’re still making money, but not until you sell it.
A positive-carry trade is one in which the asset you buy pays more interest than the financing costs. For example, if you can rent that house out for $500 a month or $6,000 a year, you will make a net 1% in interest. That is positive carry.
Another example of positive carry would be if you borrowed dollars at 0.23% and invested them in Australian dollars, which pay 2.66%. This is called a “carry trade,” because you put it on in order to earn the positive carry. Assuming that the AUD/USD rate doesn’t change for a whole year, you would make 2.43% using someone else’s money. Of course, the key here is the phrase “assuming that the AUD/USD rate doesn’t change.” If the AUD weakens vs USD by more than 2.4%, then you would lose money. But if the AUD appreciates vs the USD, then you would make even more.
Other examples of popular carry trades might be to borrow in yen at 0.07% and invest in Turkish Lira (TRY), which pay 11.5%, giving you 11.43% return just from the carry. If the yen depreciates as well, as we expect, then so much the better. The TRY is a popular currency among our clients for this reason.
Many investors in the FX market put on such trades. They borrow money in several of the lowest-yielding currencies and then invest the funds in several of the highest-yielding currencies. You can even buy mutual funds that do this systematically, for example buying the top three yielding G10 currencies and selling the bottom-yielding three with rebalancing every month, or ones that include emerging market currencies as well, etc.