The carry trade is an investing strategy in which an investor borrows money in one country at a low interest rate and invests it in another country at a higher rate. The carry trade takes advantage of differences in interest rates in different countries - which often come about as a result of different central bank actions. For example, the central bank in one country may lower interest rates to stimulate the economy, while a central bank in another country might keep interest rates high to fight inflation.
Japanese Carry Trade Example
Carry trades are common instruments in the currency markets. One of the most popular carry trades have been to borrow money in Japan and use it to invest in other countries. This has been fueled by a low Japanese interest rate. For example: An investor could borrow money at Japan at 2% interest and invest it in US treasuries at 3% interest -- allowing the investor to keep the excess 1%.
Currency carry trades bear the risk of changing exchange rates. In the example above, the investor could potentially lose money if the US dollar fell in value against the Japanese Yen.
