Forex Carry Trades

Carry trades entail going long on a high yielding currency and shorting a low-yielding currency. 

For example, New Zealand currently has interest rates at 7.25%.  Japan has a 0% interest rate in place.  To execute the carry trade, one would go long on the NZD/JPY currency pair.  At the close of each day, you would profit 7.25 percent or 725 basis points.  This assumes that the spot rate remains static.  If the NZD/JPY pair is in an uptrend, you profit from the interest and the capital appreciation.

Carry trades are said to work best when investors are in risk-seeking mode or low risk aversion.  Inversely, they are least profitable during times of high risk aversion.  

This is hindsight and correct me if I’m wrong but if you had gone long on the NZD/JPY back in the beginning of 2005 and exited at the December high, you would have gained an estimated 1200 pips plus the interest of carrying the trade. 

1 lot trade

Capital Appreciation: 1300 pips x 8.50 = $11,500
Interest: About $14 a day x  240 days = $3,360

The pair has since retraced about 900 pips. 

$14 a day in interest isn’t alone worth it for the average day-trader which is why carry trade strategy is one of the favorite amongst global macro hedge funds and investment banks.  The interest alone for an investment bank with high leverage could be quite lucrative.

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