Currency

The term carry trade without further modification refers to currency carry trade: investors borrow low- yielding currencies and lend (invest in) high-yielding currencies. It tends to correlate with global financial and exchange rate stability, and retracts in use during global liquidity shortages.

The risk in carry trading is that foreign exchange rates may change to the effect that the investor would have to pay back more expensive currency with less valuable currency. In theory, according to uncovered interest rate parity, carry trades should not yield a predictable profit because the difference in interest rates between two countries should equal the rate at which investors expect the low-interest-rate currency to rise against the high-interest-rate one. However, carry trades weaken the currency that is borrowed, because investors sell the borrowed money by converting it to other currencies.

By early year 2007, it was estimated that some US$1 trillion may be staked on the yen carry trade. Since the mid-90's, the Bank of Japan has set Japanese interest rates at very low levels making it profitable to borrow Japanese yen to fund activities in other currencies. These activities include subprime lending in the USA, and funding of emerging markets, especially BRIC countries and resource rich countries.