The Currency Carry Trade: A Valuable Money-Swap Tactic

A trade known as the currency carry trade seeks to profit from the difference in the interest rates between two countries. With interest rates near zero percent in the United States, foreign interest rates become relatively higher in general. Although there is uncertainty in foreign exchange markets, the currency carry trade is a less risky way to speculate in foreign exchange markets.

An example of the carry trade is as follows: imagine you are looking to finance a carry trade using the U.S. dollar to take advantage of the higher interest rates in Australia. Generally, the interest rate in Australia is 4.25 percent ,and the interest rate in the U.S. is 0.25 percent. This means on average there is a 4.00 percent higher interest rate in Australia. This carry trade would involve simultaneously selling the U.S. dollar and buying the Australian dollar.

Keep in mind, foreign exchange markets involve a degree of leverage. This means the swap in that is received from the positive difference between the currencies' interest rates will be a greater investment return when using leverage. With a conservative 10:1 leverage ratio, a 4.00 percent positive carry equates to a 40 percent return on capital, all else equal.

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