Carry Trade Defined, or Why Interest Rates Matter: QuickTake Q&A

Here’s what sounds like a surefire way to improve an asset’s returns: Use cheaper money to buy it. That’s the core of what’s known as a foreign-currency carry trade. Investors take advantage of a difference in interest rates between two countries to borrow where the rate is low and invest where it’s high. Investors have employed the trade for decades to bet on currencies including the Australian dollar and the Mexican peso; a more recent strategy has been to borrow in U.S. dollars to invest in emerging markets such as Russia and Brazil. Warning: Carry trades are a pretty good way to lose large sums of money, given that exchange rates are prone to unpredictable corrections that can force sudden, painful unwinding of investments.

In finance speak, the“carry” of an asset is the return obtained from holding it. So a carry trade involves buying a currency and “carrying” it until you make a profit.