What is a currency carry trade

Carry is the most popular trade in the currency market, practiced by both the largest hedge funds and the smallest retail speculators. The carry trade rests on the fact that every currency in the world has an interest rate attached to it. These short-term interest rates are set by the central banks of these countries: the Federal Reserve in the U.S., the Bank of Japan in Japan and the Bank of England in the U.K.

The idea behind the carry is quite straightforward. The trader goes long the currency with a high interest rate and finances that purchase with a currency with a low interest rate. For example, in 2005, one of the best pairings was the NZD/JPY cross. The New Zealand economy, spurred by huge commodity demand from China and a hot housing market, saw its rates rise to 7.25% and stay there, while Japanese rates remained at 0%. A trader going long the NZD/JPY could have harvested 725 basis points in yield alone. On a 10:1 leverage basis, the carry trade in NZD/JPY could have produced a 72.5% annual return from interest rate differentials, without any contribution from capital appreciation. Now you can understand why the carry trade is so popular!

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A currency carry trade is a (typically longer term) trade where a trader borrows a currency with lower interest rate and uses it to buy a currency with higher interest rate in an attempt to capture the difference between the interest rates.


The difference between the interest rates adjusted by a cost of a rollover (see "Rollover Procedure" on the below link) is called "rollover rate" or "swap rate" and is paid by a broker to a trader for every day of holding of such a trade.


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23 May 2016 by

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