What is the yen carry trade

Simply put, the carry trade involves selling a currency with a relatively low interest rate, like the yen, and using the funds to buy another currency that yields a higher interest rate, such as the New Zealand dollar.

Usually, investors borrow in a low-interest-rate currency, convert the funds into a high-interest-rate currency and lend out the resulting amount at its relatively higher interest rate, reaping a profit from the difference in interest rates.

To paint a clearer picture of how the yen carry trade works, take the example of a trader who borrows yen from a Japanese bank, converts it into US dollars and buys a bond for the equivalent sum. Assuming the US bond pays 4.5 per cent and Japan's interest rate is zero, the trader makes a profit of 4.5 per cent as long as the exchange rates of both countries do not change.

The huge risk of the carry trade is the uncertainty of exchange rates. In the example above, if the yen was to appreciate in value relative to the US dollar or vice versa, the trader would stand to lose his money.

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