Estimate profit from borrowing in a low-yield currency and investing in a high-yield currency.
e.g., JPY at ~0.1%
e.g., USD at ~5.25%
+ = funding currency weakens (favorable)
Formula: Interest Differential = Invest Rate − Borrow Rate Annual Carry = Position Size × Interest Differential FX P/L = Position Size × FX Change %
What is a Carry Trade?
A carry trade involves borrowing in a currency with low interest rates (like JPY) and investing in one with higher rates (like AUD or USD). The profit comes from the interest rate differential, but currency movements can amplify or erase gains.
Risks
Currency risk: If the funding currency strengthens, losses can exceed the interest differential
Leverage risk: Amplifies both gains and losses
Unwinding risk: During crises, carry trades unwind rapidly as traders flee to safe havens