The Credit Crisis And The Carry Trade

Broadly speaking, the term "carry trade" means borrowing at a low interest rate and investing in an asset that provides a higher rate of return. For example, assume that you can borrow $20,000 at an interest rate of 3% for one year; further assume that you invest the borrowed proceeds in a certificate of deposit that pays 6% for one year. After a year, your carry trade has earned you $600, or the difference between the return on your investment and the interest paid times the amount borrowed.


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Of course, in the real world, opportunities like these rarely exist because the cost of borrowing funds is usually significantly higher than interest earned on deposits. But what if an investor wishes to invest low-cost funds in an asset that promises spectacular returns, albeit with a much greater degree of risk? In this case, we are referring to the currency, or forex, markets, where carry quickly became one of the most important strategies. These trades allowed some traders to rake in big profits, but they also played a part in the credit crisis that struck world economic systems in 2008. Read on to find out how to execute these trades. (To learn more about currency carry trades, such as the yen carry trade, read Currency Carry Trades Deliver.)