Updated on March 2, 2023
Carry Trade is a part of currency markets where traders borrow at low yielding currency and invest in high yielding currency with higher interest rates for making quick gains. However, it is a strategic and sophisticated trade and not risk free. Thus, only technically experienced traders or institutions trade in carry trade. The profit earned between the two interest rates is called ‘interest rate differential’.
Risks of Carry Trade
Risks of Carry Trade are:
a) Currency markets are highly volatile and price fluctuations are huge. A Carry Trade strategy must take this into account and manage risk of the trade accordingly.
b) Any sudden and major changes to either currencies can wipe out all profits as well as the capital employed.
Advantages of Carry Trade
Advantages of Carry Trade are:
a) Higher interest in addition to the trading profit.
b) The interest component lowers the risk to some extent.
c) It can make good profits when currencies are largely stable.