Carry trade
Borrowing where interest is low, investing where it is high, and why a currency move can wipe out the gain
Policy rates as on 16 October 2026; exchange rates from June-August 2024
Verified 16 October 2026
For training and education only. Not investment advice.
Trainer notes
Ask the room: if you could borrow at 0.5% and earn 5%, what could go wrong? Collect answers. Most will say default. The answer this deck builds to is the exchange rate.
A carry trade collects a small, steady interest gap and takes the risk of a large, sudden currency loss.
It tends to pay while exchange rates are calm. When the borrowed currency jumps, many holders try to exit at once, and the rush to exit moves markets further.
Trainer notes
Keep the asymmetry in front of the room: small gains most of the time, a large loss occasionally. Market people describe it as picking up coins in front of a steamroller.
Four terms to know first
Funding currency
The currency borrowed because its interest rate is low. In 2024 the yen was the main one.
Target currency
The currency the borrowed money is converted into and invested in, because it pays a higher rate.
Carry
The interest gap between the two: what the investment earns minus what the loan costs.
Unwind
Closing the trade: selling the target currency and buying back the funding currency to repay the loan.
Take-away: The carry is set on day one at fixed rates. The exchange rate when the trade closes is not.
Source for the yen as the main funding currency: BIS Bulletin No 90, 27 Aug 2024.
Trainer notes
BIS describes these strategies as borrowing in low-yielding currencies, such as yen, to invest in higher-yielding assets elsewhere. They are often set up with currency forwards, swaps and options rather than actual loans.
A carry trade, with real arithmetic
THE SET-UP
An investor borrows ¥16,000,000 for one year at 0.5% and converts it at ¥160 per dollar into $100,000.
The dollars earn 5% for the year.
- After a year: $100,000 × 1.05 = $105,000. The yen owed is ¥16,000,000 × 1.005 = ¥16,080,000.
- Rate still ¥160: $105,000 = ¥16,800,000. Gain ¥720,000, or 4.5% of the amount borrowed.
- Yen strengthens to ¥144: $105,000 = ¥15,120,000. Loss ¥960,000, or 6% of the amount borrowed.
- Break-even: ¥16,080,000 ÷ $105,000 = ¥153.14. A fall in the dollar of about 4.3% wipes out the gain.
Result: The interest gap is small and known. The currency move can be large and is unknown.
Illustration with assumed rates and an assumed exchange rate. Not a forecast.
Trainer notes
Many such trades use borrowed money or derivatives, so the investor's own capital is a fraction of the position. A 6% loss on the position can then be a much larger loss on that capital, which is what forces quick exits.
Why hedging removes the gain
Same investor, same numbers. What happens if the currency risk is locked away on day one?
Agree the rate in advance
The investor contracts today to sell $105,000 in one year at a fixed 'forward' exchange rate.
Forward builds in the gap
Forward = spot × (1 + yen rate) ÷ (1 + dollar rate) = ¥160 × 1.005 ÷ 1.05 = ¥153.14 per dollar.
The gain disappears
$105,000 × ¥153.14 = ¥16,080,000, exactly the yen owed. Hedged, it makes nothing before costs.
So carry is pay for risk
The interest gap is what the market pays for bearing the currency risk. Remove the risk and the pay goes too.
Illustration with assumed figures. The forward-rate formula is the standard covered interest parity relationship.
Trainer notes
In practice forward rates track this relationship closely but not perfectly, and dealers charge a spread. The break-even rate on the previous slide and the forward rate are the same number. That is not a coincidence.
August 2024: the yen jumps
| Yen per US dollar | |
|---|---|
| 28 Jun | 160.88 |
| 10 Jul | 161.73 |
| 24 Jul | 153.39 |
| 31 Jul | 150.38 |
| 2 Aug | 146.98 |
| 5 Aug | 143.95 |
| 9 Aug | 146.49 |
| 30 Aug | 145.95 |
Read the chart
- A falling line means a stronger yen: fewer yen buy one dollar.
- From 10 July to 5 August a dollar bought about 11% fewer yen.
- For a yen-funded trade, that is a loss on the currency alone.
- Daily rates for the yen as published by the US Federal Reserve in its H.10 release.
Source: Federal Reserve, H.10 historical rates for the Japanese yen (release of 13 Oct 2026). Axis starts at 140.
Trainer notes
The move: (161.73 − 143.95) ÷ 161.73 = 11.0%. Seen from the yen side, the yen's value in dollars rose about 12.4%. Compare that with a carry of about 5 percentage points a year at the time.
How the 2024 unwind unfolded
July: the trend turns
From the first half of July the yen stopped weakening, and a brief sell-off with signs of carry unwinding came on 24 July.
31 July: Japan raises rates
The Bank of Japan set its overnight rate target at around 0.25%, up from 0 to 0.1%. The US Fed held its rate at 5.25% to 5.50%.
2 August: US jobs data
A somewhat weak US labour market report led investors to reassess the risk of a US recession.
5 August: the peak
Japan's TOPIX index fell 12% in a day. The US VIX briefly topped 60 in off-hours trading.
By 9 August: calmer
The S&P 500 had regained its losses since that Monday and the TOPIX most of its losses.
Sources: BIS Bulletin No 90, 27 Aug 2024; Bank of Japan statement, 31 Jul 2024; FOMC statement, 31 Jul 2024.
Trainer notes
BIS notes the US data could hardly be read as a clear sign of recession; the size of the reaction came from leverage unwinding in thin August markets. The quick recovery that week was not guaranteed and should not be presented as the usual outcome.
Why unwinds tend to be sudden
- ¥40 tn
Crowded positions
BIS put FX carry trades at a rough ¥40 trillion ($250 billion) going into August 2024, and says that may be too low.
Leverage and margin
When volatility rises, lenders ask for more margin. Holders sell to raise it, which pushes prices further and lifts volatility again.
Calm breeds risk
Long spells of low volatility draw more borrowed money into carry trades, which makes the eventual rush to exit larger.
Source: BIS Bulletin No 90, The market turbulence and carry trade unwind of August 2024, 27 Aug 2024.
Trainer notes
BIS calls the episode another example of volatility made worse by procyclical deleveraging and higher margins. It also says the true size of carry positions is hard to measure, because much of it sits in over-the-counter derivatives.
Where policy rates stand
The gap between US and Japanese policy rates was about 5 percentage points in August 2024. It is under 3 points now.
- US FEDERAL FUNDS
- 3.75-4%Target range, raised by 0.25 point on 16 September 2026. It was 5.25% to 5.50% in July 2024.
- BANK OF JAPAN
- 1.25%Target 'around 1.25%' from 24 September 2026. It was around 0.25% from 1 August 2024.
- RBI REPO RATE
- 5.50%Raised from 5.25% on 7 October 2026.
Sources: FOMC statements, 31 Jul 2024 and 16 Sep 2026; Bank of Japan statements, 31 Jul 2024 and 18 Sep 2026; RBI Monetary Policy Statement, 7 Oct 2026.
Trainer notes
These are policy rates, not market rates, and they change at each meeting; check the date. A carry trade looks at the rates actually earned and paid, which differ from policy rates. We describe the gap; we do not say whether any trade is worth doing.
If you learnt this from older material
What older decks say
- A carry trade means borrowing cash abroad and depositing it at home.
- US dollars are the usual low-rate currency to borrow.
- The risk is a gradual drift in the exchange rate.
What holds now
- Much of it runs through currency forwards, swaps and options (BIS, Aug 2024).
- In 2024 the yen was the main funding currency; US rates were 5.25% to 5.50%.
- In 2024 a dollar bought about 11% fewer yen in under four weeks.
Take-away: The idea has not changed. The funding rates and the speed of the risk have.
Sources: BIS Bulletin No 90, 27 Aug 2024; FOMC statement, 31 Jul 2024; Federal Reserve H.10 yen rates.
Trainer notes
The 11% figure is the change in yen per dollar from 10 July to 5 August 2024. Japan's rates have risen: the Bank of Japan ended negative rates in March 2024 and targets about 1.25% from 24 September 2026. Funding costs differ by currency; check the date.
Four things people get wrong
Misconception'The interest gap is free money.'
What is trueIt is payment for taking currency risk. Hedge the currency with a forward and the gap disappears.
Misconception'Only currency traders are affected.'
What is trueOn 5 August 2024 the unwind spread to shares: TOPIX fell 12% and the S&P 500 3.0%.
Misconception'A higher rate means a rising currency.'
What is trueNot necessarily. The forward rate prices the higher-rate currency at a discount, and spot rates can move either way.
Misconception'It was all about Japan's rate rise.'
What is trueBIS points to a mix: the rate rise, weak US jobs data, heavy leverage and thin August trading.
Trainer notes
Use these as conversation starters if a client asks why global news moved their Indian equity fund. Explain the mechanism; do not predict the next episode.
Check yourself
Question 1: An investor borrows at 1% and invests in another currency at 6%. That currency falls 8% against the borrowed one over the year. Did the trade make or lose money?
Answer: It lost money. The carry of about 5 points is smaller than the 8% currency loss: 1.06 × 0.92 = 0.9752 per unit, against 1.01 owed, a loss of about 3.5% of the amount borrowed.Question 2: Why does hedging a carry trade with a forward contract remove the gain?
Answer: The forward rate already builds in the interest gap: forward = spot × (1 + funding rate) ÷ (1 + target rate). Locking it in gives back exactly what is owed, before costs.Question 3: Name two things that turned a modest US data surprise into a large market move in August 2024.
Answer: Any two of: crowded yen-funded carry positions, leverage and margin calls, thin August trading, the yen's reversal from early July changing the incentives.
Sources and disclaimer
Sources for the figures in this explainer
- Episode, TOPIX −12% and VIX above 60 on 5 Aug 2024, ¥40 trillion estimate: BIS Bulletin No 90, The market turbulence and carry trade unwind of August 2024, 27 Aug 2024.
- Yen per US dollar, 2024: Federal Reserve, H.10 historical rates for the Japanese yen, release of 13 Oct 2026.
- Bank of Japan: statements of 19 Mar 2024 (0 to 0.1%), 31 Jul 2024 (around 0.25%) and 18 Sep 2026 (around 1.25%, effective 24 Sep 2026).
- US federal funds target: FOMC statements of 31 Jul 2024 (5.25% to 5.50%) and 16 Sep 2026 (3.75% to 4%).
- RBI repo rate 5.50% from 7 Oct 2026: RBI Monetary Policy Statement, Press Release 2026-2027/1264.
- The investor, loan amounts and rates in the worked examples are assumptions computed exactly. They are not market quotes.
This material is for training and investor education only. It is not investment, tax or legal advice and is not a recommendation to buy, sell or hold any security or scheme. Examples use assumed figures unless a source and date are shown. Mutual fund investments are subject to market risks; read all scheme related documents carefully. Trustner Asset Services Pvt. Ltd. is an AMFI-registered Mutual Fund Distributor (ARN-286886).