What Is Positive Carry Trade?

Positive carry trade refers to a trading strategy where an investor borrows funds in a low-interest-rate currency to invest in assets that yield a higher interest rate. This strategy aims to profit from the difference in interest rates, known as the "carry," and is typically used with fixed-income securities like bonds.

How Positive Carry Trade Works

• Borrowing Funds: An investor borrows money in a currency with a low interest rate, such as the Japanese yen or Swiss franc, which are often characterized by their stability and low borrowing costs.
• Investing in Higher-Yield Assets: The borrowed funds are then invested in assets that offer higher interest rates, such as U.S. Treasury bonds or corporate bonds.
• Profits from Interest Rate Differential: The investor profits from the difference between the interest rates on the borrowed funds and the invested assets. For example, if an investor borrows yen at a 0.5% interest rate and invests in U.S. bonds yielding 3%, they retain a positive carry of 2.5%.

Key Characteristics

• Interest Rate Differential: The core principle is to exploit interest rate differentials between currencies or assets.
• Hedging Against Currency Risk: Traders often use forward contracts or options to hedge against currency risk, ensuring that they can convert their investments back to the original currency at a locked-in exchange rate.
• Timing Considerations: The strategy is sensitive to economic conditions and interest rate changes. If interest rates rise unexpectedly, it can lead to losses for investors who have not hedged their positions.

Example

Suppose an investor borrows ¥100 million at an interest rate of 0.5% per annum. They then convert this to U.S. dollars and invest in U.S. Treasury bonds yielding 2% per annum. If the exchange rate remains stable, after one year, they will receive $102 million (including interest) and must repay ¥100.5 million. If they convert back at the same exchange rate, they will retain a profit of ¥149 million in local currency terms.

Conclusion

Positive carry trade is a strategic approach that leverages interest rate differentials to generate profits. It involves borrowing in low-interest environments and investing in higher-yielding assets, but it also carries risks associated with market fluctuations and changes in interest rates.