Definition
A carry trade borrows or sells a low-interest-rate currency to hold a higher-interest-rate one, aiming to earn the interest-rate difference. It is exposed to exchange-rate moves that can erase or exceed that difference.
How it works
The expected income, called carry, is roughly the interest rate on the currency held minus the rate on the currency borrowed, adjusted for costs. In forex it also appears through swap or rollover charges and forward points, which depend on the broker and contract.
The return is only partly interest: if the high-yielding currency falls against the funding currency, the exchange-rate loss can outweigh the carry. Carry positions can look steady for long periods and then unwind quickly during market stress, and leverage amplifies that shift.
Formula / convention
Approximate return ≈ (interest rate on the held currency − interest rate on the borrowed currency) + percentage change in the held currency against the borrowed currency − costs
Illustrative example
Illustrative: the funding currency pays 0.5% a year and the held currency pays 4.5%, so the gross carry is 4.5% − 0.5% = 4.0% a year. If the held currency also falls 5.0% against the funding currency, the approximate result before costs is 4.0% − 5.0% = −1.0%. With 5 times leverage, the change in the capital committed is roughly −1.0% × 5 = −5.0%.
What to watch for
Carry is not a risk-free yield: sudden currency moves, funding costs, changing interest rates and margin calls can turn an apparent income stream into a loss. Interest differences earned in the past do not indicate future results.