How this instrument works
A carry trade is a strategy, not a pricing formula: borrow in a currency with a low interest rate, convert the proceeds into a currency with a higher interest rate, and hold the higher-yielding asset for the rate differential. Macro hedge funds, bank proprietary desks and margin-trading retail investors have run versions of this trade for decades on pairs like the Japanese yen funding an Australian dollar or Mexican peso position, collecting the gap between what they pay to borrow and what they earn holding.
The return has exactly two moving parts, which is why the formula is a plain sum rather than a ratio or a discounted series. The rate differential — the high-yield currency's rate minus the funding currency's rate — is earned steadily over the holding period regardless of price action. The FX change applies on top of that, because the position's value is measured back in the funding currency, so any move in the exchange rate adds to or subtracts from the interest already collected.
The instrument deliberately excludes leverage, roll costs and the bid-ask spread paid on each conversion, because those figures depend on the broker, the margin used and the exact dates traded. What it isolates is the underlying arithmetic every carry trade is built on — the number a trader checks before deciding whether a rate gap is worth the currency risk it carries.
- Enter High-yield currency interest rate, % — the rate paid on the currency you would hold.
- Enter Funding currency interest rate, % — the rate you would pay to borrow the funding currency.
- Enter Currency appreciation of the high-yield currency, % — the FX move over the holding period; use a negative figure for a depreciation.
- Read Carry trade return, % — the rate differential and the FX move added together.
- Push the FX field more negative to find the depreciation that cancels out your differential entirely.
Worked example — a 7% differential against a 2% currency slide
A trader funds the position by borrowing at 1% in a low-yield currency and holds an 8% yielding currency instead. Subtracting the two gives a 7% rate differential — the carry the strategy is named for — before any currency movement enters the arithmetic at all.
Over the holding period the high-yield currency slips 2% against the funding currency, entered as fxChange = −2. Adding that to the 7% differential leaves a 5% return: the trade still made money because the differential was wide enough to absorb the currency's decline, though a slide past 7% would have flipped this same formula negative.
Questions
What is a carry trade, exactly?
It borrows in a currency with a low interest rate and holds an asset in a currency with a higher one, earning the rate differential as return. Macro hedge funds, bank trading desks and margin-trading retail investors run versions of it on pairs such as the yen funding a New Zealand dollar or Mexican peso position, betting the currency won't move against them by more than the rate gap they collect.
Why does the FX change matter as much as the two interest rates?
Because it can erase or double the interest gain the trade depends on. The differential is earned steadily regardless of price action, but the FX change applies to the whole position's value, so a modest adverse move can outweigh a wide rate gap. In the golden example above, the trade nets 5% only because the 2% slide stayed smaller than the 7% differential feeding it.
What is a carry unwind and why does it matter here?
It is when many traders holding the same carry position close it at once, usually after a shock, pushing the funding currency up and the high-yield currency down together — the exact fxChange term in this formula moving sharply negative right when it hurts most. The yen-funded carry trades that unwound in August 2024 are a recent example: months of collected differential turned into a loss within days.
Does this return include leverage or trading costs?
No. This is the unlevered, cost-free return implied purely by the rate differential and the FX move entered. Real carry positions are usually leveraged several times over through margin or FX forwards, which multiplies both the differential earned and any currency loss, and every conversion also crosses a bid-ask spread this simple sum leaves out entirely.
How is this different from a forward premium calculation?
A forward premium restates a quoted forward and spot rate as one annualized percentage — it prices what the market currently charges for future delivery of a currency. This instrument instead simulates a strategy's realized return by adding an assumed rate gap to an assumed FX move, so the inputs are two interest rates and a currency change rather than a forward price.
Which interest rates should I actually enter?
Use the short-term rate each currency pays over your holding period — a central bank policy rate or a comparable money-market yield — not a long-term bond yield. Mismatched maturities between the two rates make the differential meaningless, since the calculation compares what you'd earn or pay over different lengths of time, not the same window twice.
References
- SEC Investor.gov — Foreign Currency (Forex) Trading for Individual Investors
- CFTC — Eight Things You Should Know Before Trading Forex
Read this first: This instrument shows arithmetic, not advice. Real offers add fees, taxes and terms that vary by lender and place — verify the figures against your actual paperwork before deciding anything.