Carry Trade Calculator
Our carry trade calculator will help you calculate the profit you can earn through executing the carry trade trading strategy. This calculator computes the profit due to the differential of the lending rate and the borrowing rate, and also the spot rate differential. You can check out our profit calculator to understand more about profitability.
This article will explain what a carry trade is and how to calculate the carry trade profit. Furthermore, we will help you understand how does a carry trade work by showing you some practical examples.
What is a carry trade, and how does a carry trade work? Carry trade definition
Carry trade is a famous trading strategy within the foreign exchange field. This trading strategy involves borrowing the currency with a lower interest rate and investing the proceeds in a currency with a higher interest rate. The investor aims to earn a profit by exploiting the difference in interest rates.
For example, if Currency A has an interest rate of 1% and Currency B has an interest rate of 3%, the investor will borrow Currency A by paying the 1% interest rate and invest the money into Currency B to receive the 3% interest. Please check out our real interest rate calculator and interest rate calculator to understand more about this topic.
Don't worry if this still sounds confusing to you. Everything will be clear when we explain the carry trade calculation in the next section.
How to calculate the carry trade profit? Carry trade calculation
Now, let's look at the example below to understand how a carry trade works in practice after understanding the carry trade definition.
Assuming Company Alpha has executed the carry trade (long USD and short GBP) with the following information:
- Currency exchange: GBP / USD
- Initial exchange rate: 0.85
- Settle exchange rate: 0.83
- USD interest rate: 0.75%
- GBP interest rate: 0.5%
- Number of days until the trade is settled: 180 days
- Amount invested: $1,000
Determine the lending rate and borrowing rate.
As USD has a higher interest rate, the carry trade will involve buying the USD and selling the GBP. Hence, the
lending rateis the USD interest rate, and the
borrowing rateis the GBP interest rate.
Calculate the spot rate differential.
spot rate differentialcan be calculated using the formula below:
spot rate differential = (settle exchange rate − initial exchange rate) / initial exchange rate
In our example, the
spot rate differentialis
(0.83 − 0.85) / 0.85 = -2.35%.
Determine the number of days until the trade is settled.
days until trade settlesis the number of days calculated from when the trade is initiated to the day when the trade is settled.
days until trade settlesis
Calculate the investment return
investment returncan be calculated using the formula below:
investment return = (1 + (lending rate − borrowing rate) × (1 + spot rate differential)) ^ (days / 360) − 1
investment returnfor the carry trade is
(1 + (0.75% - 0.5%) × (1 + (-2.35%))) ^ (180 / 360) − 1 = 0.122%.
Determine the amount invested
amount investedis the amount of money you have invested in executing the carry trade.
amount investedfor our example is
Calculate the carry trade profit
The last step is to calculate the
carry trade profitusing the formula below:
carry trade profit = amount invested × investment return
Thus, this example's
carry trade profitis
What are the risk of executing carry trade?
Although carry trade seems like an easy way to earn profits by exploiting the difference in interest rates, this trading strategy also comes with some risks. To understand more about this topic, please check out our risk calculator.
As carry trade earns profits based on interest rate differentials, it does not make sense for the investor to hedge their currency risk as this will eat away the profits brought by executing the carry trade. Without hedging, the investor is not exposed to currency risk. As explained above, the changes in exchange rates can hugely affect the profitability of the trade.
According to the uncovered interest rate parity, the high-yielding currency tends to depreciate against the low-yielding currency. Thus, it is possible that the spot rate movements can eliminate any profit gained through the difference in interest rates. This situation can worsen if other investors start to sell the spot rates, causing a currency crash risk.
A currency crash risk will not only eliminate the profit gained by executing the carry trade, but it will also incur huge losses. Hence, it is prudent to carry out intensive research before executing the carry trade.
What is the lending rate in carry trade?
The lending rate is defined as the interest rate that you received by lending the currency. The higher the lending rate, the higher the carry trade profit.
What is the borrowing rate in carry trade?
The borrowing rate is the interest rate that you have to pay by borrowing a certain currency. The higher the borrowing rate, the lower the carry trade profit.
What is spot rate differential?
The spot rate differential represents the percentage change in an exchange rate over a specific period, calculated by comparing the initial and settled rates. A positive spot rate differential will improve the carry trade profit, and a negative spot rate will negatively impact the profit.
What is currency risk?
Currency risk is the risk that arises from the changes in foreign currency movements. For example, if a UK-based company buys an asset in the US, it is exposed to currency risk. This is because if the USD depreciates against the GBP, the company will experience a loss.
What is the carry trade profit if the investment return is 10% on $5,000?
The carry profit will be
$500. You can calculate this by using this formula:
carry trade profit = amount invested × investment return
How can I calculate the spot rate differential?
You can calculate the spot rate differential in three steps:
Determine the initial exchange rate.
Estimate the settle exchange rate.
Compute the spot rate differential:
spot rate differential = (settle exchange rate - initial exchange rate) / initial exchange rate