Currency
See also: Foreign exchange marketThe currency carry trade is an uncovered interest arbitrage.
The term carry trade, without further modification, refers to currency carry trade: investors borrow low-yielding currencies and lend (invest in) high-yielding currencies. It is thought to correlate with global financial and exchange rate stability and retracts in use during global liquidity shortages, but the carry trade is often blamed for rapid currency value collapse and appreciation.
A risk in carry trading is that foreign exchange rates may change in such a way that the investor would have to pay back more expensive currency with less valuable currency. In theory, according to uncovered interest rate parity, carry trades should not yield a predictable profit because the difference in interest rates between two countries should equal the rate at which investors expect the low-interest-rate currency to rise against the high-interest-rate one. However, carry trades weaken the currency that is borrowed, because investors sell the borrowed money by converting it to other currencies.
By early year 2007, it was estimated that some US$1 trillion may have been staked on the yen carry trade. Since the mid-90's, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies. These activities include subprime lending in the USA, and funding of emerging markets, especially BRIC countries and resource rich countries. The trade largely collapsed in 2008 particularly in regard to the yen.
Read more about this topic: Carry (investment)
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