Business and Personal Finance Dictionary

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• CARRY TRADE
  
  Definition: A trade that consists of borrowing and paying interest in order to finance the purchase of an investment that pays a greater interest or a dividend stream. Example: In a single currency, borrowing short-term and buying bonds leads to a carry that is the coupon minus the interest on the borrowing. The yen carry trade consists of borrowing yen in the Tokyo market and paying the currently (1999) low yen rate, buying dollars in the spot market, and buying dollar bonds paying higher coupons. Application: The idea is to collect the positive carry, interest and dividends received, minus interest paid. Pricing: The trade is initially worth about zero, except for small transaction costs. Risk Management: The major risk is the depreciation in price of the long asset and appreciation in price of the short asset. However, if you get rid of that risk, then you essentially take off the trade. Comment: The yen carry trade has been a popular trade for hedge funds and others, with the yen rate around one percent and the dollar rate around five percent. However, by 6/12/99 Gretchen Morgenson was able to write, "The dollar fell 2.5 percent against the yen in four days of trading." That’s an annualized, continuously compounded rate of about 950%! Source: Gretchen Morgenson, "Once Again, Wall St. Worries About Hedge Funds," New York Times, 6/12/99.
  
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