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Definition: Carry Trade
Carry trade is a trading system in which an investor uses the funds obtained from selling currencies having a relatively low interest rate to purchase currencies having a relatively high interest rate. Or, the investor invests money borrowed from a country having a low interest rate in a country having a relatively higher interest rate. In such a scenario, the profit is the difference between the interest rates of the two financial instruments. The only risk involved here is that the interest rates are uncertain and depend on the market condition.
Formula : (high interest rate – low interest rate) * selling price of currency with
low interest rate
eg – Suppose Mr X borrows Rs 100 and invests it in a bond having an interest rate of 8% in the US. For investing in the US market, Mr X will first have to convert the rupee into US dollars. Now, if the interest rate in India is 6%, then the profit made by Mr X would be equivalent to the difference between the interest rates of the US and India i.e. 2%