Why carry trade matters
Carry can generate steady income but is exposed to exchange-rate reversal, leverage, volatility, funding, and crowded unwinds. High yield often compensates for real risk.
How it is applied
Investors compare interest differentials, forward pricing, valuation, volatility, liquidity, funding, and downside scenarios and define stop and leverage limits.
Portfolio example
Borrowing at 1% and investing at 6% offers 5% gross carry, but a 10% depreciation of the investment currency creates a net loss.
How to interpret it
Positive carry is not free return. Currency appreciation or depreciation and financing terms determine total outcome.
Limitations and common misconceptions
Returns can reverse sharply during risk aversion. Rates change, leverage forces liquidation, and transaction costs consume small differentials.
Sources and further reading
- Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives MarketsBank for International Settlements
- Exchange RatesInternational Monetary Fund
- Currency Exchange RatesCFA Institute