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Question:


What is the carry trade?
-EconomicFreak81


Answer:


A carry trade is a tool used by hedge funds and others who speculate in financial markets to increase the amount of assets that they can control with any given amount of money. A carry trades involves borrowing in a currency with very low interest rates, such as the yen in the mid-1990s or the yen, dollar or euro today. The speculators combine the borrowed money with their own capital to buy and sell stocks, bonds, gold or anything else they fancy. The low interest rates on the borrowed money reduce the cost of financing their activities. The added leverage means that they can reap bigger gains if the bets they take are successful, but it also means that their losses will be bigger if they get it wrong.
 
That makes the carry trade a risky proposition. What can make it all the more risky - downright dangerous sometimes - is that beyond the trading of volatile assets with leverage that enhances the swings, speculators using a carry trade are also betting that the currency that they have borrowed in will decline in value or at least remain stable. History shows that that tends to happen for a while, as the borrowing done in executing the carry trade depresses the currency being used, but what goes down often comes back up with startling speed. As the currency rises, the debt owed by the speculators starts to increase and some are forced to close out their positions and repay the money, which causes further currency gains and so on. The message from the history of carry trades is: Don't try this at home, or anywhere else either.
-Conrad de Aenlle



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