The carry of an asset is the return obtained from holding it (if positive), or t

he cost of holding it (if negative) (see also Cost of carry).[1]

For instance, commodities are usually negative carry assets, as they incur stora
ge costs or may suffer from depreciation, but in some circumstances, appropriate
ly hedged commodities can be positive carry assets if the forward/futures market
is willing to pay sufficient premium for future delivery.
This can also refer to a trade with more than one leg, where you earn the spread
between borrowing a low carry asset and lending a high carry one; such as gold
during financial crisis, due to its safe haven quality.
Carry trades are not usually arbitrages: pure arbitrages make money no matter wh
at; carry trades make money only if nothing changes against the carry's favor.
Contents [hide]
1
Interest rates carry trade / Maturity transformation[2]
2
Currency
2.1
Known risks
3
See also
4
Notes
5
External links
Interest rates carry trade / Maturity transformation[2][edit]
See also: Interest rates
For instance, the traditional income stream from commercial banks is to borrow c
heap (at the low overnight rate, i.e., the rate at which they pay depositors) an
d lend expensive (at the long-term rate, which is usually higher than the shortterm rate).
This works with an upward-sloping yield curve, but it loses money if the curve b
ecomes inverted. Many investment banks, such as Bear Stearns, have failed becaus
e they borrowed cheap short-term money to fund higher interest bearing long-term
positions. When the long-term positions default, or the short-term interest rat
e rises too high (or there are simply no lenders), the bank cannot meet its shor
t-term liabilities and goes under.
According to a popular anecdote, traditional commercial banking was characterize
d as a "3-6-3" business: bankers gathered deposits at 3%, lent them at 6% (thus
earning the 3% spread), and were on the golf course by 3 pm.[3] While this may h
ave been close to the truth in the market of the 1950s to the 1970s, the modern
competitive market ensures that profits are kept more in line with perceived ris
ks[citation needed].
Currency[edit]
See also: Foreign exchange market
The currency carry trade is an uncovered interest arbitrage.
The term carry trade, without further modification, refers to currency carry tra
de: investors borrow low-yielding currencies and lend (invest in) high-yielding
currencies. It is thought to correlate with global financial and exchange rate s
tability and retracts in use during global liquidity shortages,[4] 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 valua
ble currency. In theory, according to uncovered interest rate parity, carry trad
es should not yield a predictable profit because the difference in interest rate
s between two countries should equal the rate at which investors expect the lowinterest-rate currency to rise against the high-interest-rate one. However, carr
y trades weaken the currency that is borrowed, because investors sell the borrow

ed money by converting it to other currencies.

By early year 2007, it was estimated that some US$1 trillion may have been stake
d on the yen carry trade.[5] Since the mid-90's, the Bank of Japan has set Japan
ese interest rates at very low levels making it profitable to borrow Japanese ye
n to fund activities in other currencies.[6] These activities include subprime l
ending in the USA, and funding of emerging markets, especially BRIC countries an
d resource rich countries. The trade largely collapsed in 2008 particularly in r
egard to the yen.
Most research on carry trade profitability was done using a large sample size of
currencies.[7] However, small retail traders have access to limited currency pa
irs, which are mostly composed of the major G20 currencies, and experience reduc
tions in yields after factoring in various costs and spreads.[8]
Known risks[edit]
The 2008 2012 Icelandic financial crisis has among its origins the undisciplined u
se of the carry trade. Particular attention has been focused on the use of Euro
denominated loans to purchase homes and other assets within Iceland. Most of the
se loans defaulted when the relative value of the Icelandic currency depreciated
dramatically, causing loan payment to be unaffordable.
The US dollar and the Japanese yen have been the currencies most heavily used in
carry trade transactions since the 1990s. There is some substantial mathematica
l evidence in macroeconomics that larger economies have more immunity to the dis
ruptive aspects of the carry trade mainly due to the sheer quantity of their exi
sting currency compared to the limited amount used for FOREX carry trades,[citat
ion needed] but the collapse of the carry trade in 2008 is often blamed within J
apan for a rapid appreciation of the yen. As a currency appreciates, there is pr
essure to cover any debts in that currency by converting foreign assets into tha
t currency. This cycle can have an accelerating effect on currency valuation cha
nges. When a large swing occurs, this can cause a carry reversal. The timing of
the carry reversal in 2008 contributed substantially to the credit crunch which
caused the 2008 global financial crisis, though relative size of impact of the c
arry trade with other factors is debatable. A similar rapid appreciation of the
US dollar occurred at the same time, and the carry trade is rarely discussed as
a factor for this appreciation.
See also[edit]
Convenience yield
Carrying charge
Cost of carry
Demurrage (currency)
Interest rate parity
Covered interest arbitrage
Spot-future parity
Endaka
Notes[edit]
Jump up ^ Carry, SSRN, April 2014
Jump up ^ Maturity-transformation: http://www.macroresilience.com/2010/04/04/mat
urity-transformation-and-the-yield-curve/
Jump up ^ The 3-6-3 rule : an urban myth? by John R. Walter, Federal Reserve Ban
k of Richmond Economic Quarterly
Jump up ^ CFR Effect of the Rising Yen, March 14, 2007 retrieved 3-15-2007
Jump up ^ What keeps bankers awake at night?, The Economist, Feb 1st 2007
Jump up ^ http://www.economagic.com/em-cgi/data.exe/bjap/ehdis01
Jump up ^ Study shows FX Carry trade Really Does Work By William Kemble-Diaz, Wa
ll Street Journal
Jump up ^ Carry Trade Strategies for Retail Traders
External links[edit]

The Yen Carry Trade Revisited

The Unwinding of the Carry Trade Has Finally Hit Currencies by Jeffrey Frankel,
Harvard Kennedy School, Oct. 29, 2008
The Effects of the Yen Carry Trade Unwinding
"GETTING TECHNICAL: A Secret Time Bomb Made of Gold"
An explanation of the carry trade
Mother of all carry trades faces an inevitable bust by Nouriel Roubini, 1 Nov 20
09
Carry Trades and Speculative Dynamics by Guillaume Plantin and Hyun Song Shin, M
ay 2010. Explains the dynamics of the carry trade by the example of Iceland and
then goes on to develop a mathematical model for the exchange rate movements cau
sed by carry trades.
Categories: InvestmentFinancial accounting
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