In Forex, a carry trade involves borrowing a currency with a lower interest rate, converting the funds into a currency with a higher rate of interest and lending it out in that same currency. This might be achieved by buying debt instruments like government bonds. Effectively, the investor is buying money (borrowing) for less than they are selling it (lending).
The biggest issue with carry trades is that while the investor can earn a risk-free gain from the differential in interest rates, if the price of the currency which has been purchased to lend drops, the capital loss will exceed the interest earned (potentially by a very substantial amount).
Contributed by: Ralph Windsor
The biggest issue with carry trades is that while the investor can earn a risk-free gain from the differential in interest rates, if the price of the currency which has been purchased to lend drops, the capital loss will exceed the interest earned (potentially by a very substantial amount).
External Links
Definition of carry tradehttp://lexicon.ft.com/Term?term=carry-trade
Definition of Carry Trades provided by FT.com
FX Carry Tradehttp://quantpedia.com/screener/details/5
Quantapedia article about Carry Trades. Describes a simple currency rotational strategy involving going long three currencies with highest interest rates and short three currencies with lowest rates.
Forex Carry Trade Strategieshttp://www.forextraders.com/forex-strategy/forex-carry-trade-strategies.html
forextraders.com article explaining the basics of Carry Trades and the associated risks.
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