A currency carry trade seeks income from an asset in one currency financed in another. Positive interest income does not guarantee a positive overall result: an adverse exchange rate can leave the converted investment insufficient to repay the debt. Distinguish the loan-and-asset construction, a derivative exposure and the financing terms of a retail currency CFD.

What the carry trade actually is

In the textbook construction, borrow the funding currency, exchange it spot and buy an interest-bearing asset in the investment currency. BIS distinguishes this from synthetic exposure through forwards, FX swaps or options. An outright forward can create currency exposure without a conventional cash loan or daily interest credit from a broker. Income timing and obligations depend on the contracts.

A retail FX CFD is a different contract: its price result and financing are calculated under the provider’s terms, without making the client the owner of a foreign deposit. Margin is not that deposit’s principal. To compare outcomes, retain the asset and debt currencies, actual conversion or fill prices, financing and costs separately. A policy-rate table alone does not promise a positive platform swap.

Why not add the two rate differences?

Each period changes the next interest base for both asset and debt. Keep their currencies separate first.

Scroll sideways to see the full diagram

Why not add the two rate differences?Our two-half-year model starts with a 10,000 AUD asset and 1,000,000 JPY debt at 100 JPY/AUD. The asset rises 3%, then falls 1%, reaching 10,197 AUD. Debt rises 0.5% each period to 1,010,025 JPY. The final exchange rate remains 100 JPY/AUD. Asset value of 1,019,700 JPY minus debt gives 9,675 JPY, rather than 10,000 JPY from simply adding rates. The diagram shows amounts, not height-scaled bars.Compounding applies to both sidesInitial and final rate: 100 JPY per AUDStartAssets: 10,000 AUDDebt: 1,000,000 JPYNext period: +3%Next period: +0.5%After half-year IAssets: 10,300 AUDDebt: 1,005,000 JPYNext period: −1%Next period: +0.5%After half-year IIAssets: 10,197 AUDDebt: 1,010,025 JPY10,197 AUD × 100 = 1,019,700 JPY1,019,700 − 1,010,025 = 9,675 JPYModel result before omitted costs

Our two-half-year model: borrow 1,000,000 JPY; exchange rate at both start and end is 100 JPY per AUD; buy an asset for 10,000 AUD. Asset returns are +3% and −1%; debt accrues +0.5% each half-year. Compound after each period. There are no distributions, hedges, early exits, spreads, fees or taxes. This is an invented example, not an available financing offer.

Asset: 10,000 × 1.03 × 0.99 = 10,197 AUD. Debt: 1,000,000 × 1.005 × 1.005 = 1,010,025 JPY. Converting the asset at the final rate gives 1,019,700 JPY, leaving 9,675 JPY. Simply adding 3% −1% −0.5% −0.5% gives 10,000 JPY, overstating this result by 325 JPY.

BIS distinguishes funding and asset currencies and highlights exchange-rate and funding risk. Actual terms and costs need separate checks; the positive result of this fictitious model is no promise about carry trades.

Compounding both currencies gives 9,675 JPY, rather than the simplified 10,000 JPY.

Forward pricing and provider financing are different calculations

Covered interest parity is a textbook relation for otherwise comparable assets after exchange risk is hedged. BIS documents why actual cross-currency bases can persist through liquidity, credit and balance-sheet constraints; it is not an unconditional arbitrage opportunity for a retail account. OANDA (Canada) Corporation gives a concrete provider example: FX funding rates use blended liquidity-provider tom-next rates adjusted for an instrument-specific administrative fee. Check that entity’s current long/short rate units and settlement calendar. Its typical Wednesday adjustment and holiday exceptions are product rules rather than a universal triple-swap night. See what a forex swap is and interest-rate parity for the separate concepts.

For a CFD, calculate the price result from actual entry and exit fills, add booked financing and subtract other costs. Do not subtract spread again if it is already represented in the fill prices. A rate may be a debit rather than a credit and may change while the position is held. Inspect instrument units, long/short rates, administrative adjustments and currency conversion rather than assume a constant share of a central-bank rate gap.

The classic examples: cheap yen, costly dollar

The BIS September 2024 analysis identifies comparatively low yen rates as one reason for yen funding and separates that incentive from the difficulty of measuring actual carry positions. Borrowing or a net derivative obligation is not itself proof that every yen-funded transaction is carry. Low policy rates also do not mean that a particular borrower can obtain free credit or that every AUD/JPY or USD/JPY account receives positive financing.

The USD/JPY carry trade article discusses a particular currency pair; the broader watch on Fed, ECB and Bank of Japan policy provides policy context. Our next loan-and-asset exercise uses invented contract rates, not current central-bank rates, broker terms or a historical trade. Forward hedging would require the agreed forward price and a different calculation.

Positive financing can be outweighed by an exchange-rate loss. Carry income is variable, and leverage increases the exposure to adverse price moves.

The risk that is easy to overlook

Leverage limits depend on the jurisdiction, client status, provider and product. As a historical reference, ESMA’s 2018 temporary retail CFD decision used 3.33% initial margin for pairs made from two of USD, EUR, JPY, GBP, CAD and CHF, and 5% for pairs containing another currency. AUD/JPY and NZD/JPY fall into that latter category, equivalent to 20:1 in that decision. Article 4 limited the measure’s initial application to three months from 1 August 2018; this notice alone does not establish today’s rule for every account. Separately, assuming exposure twenty times the initial margin, a one-percent adverse price move is about twenty percent of that margin before costs, not necessarily twenty percent of the whole account.

BIS Bulletin 90 analyses early-August 2024 turbulence following changing policy expectations and the US labour-market release on 2 August, amplified by deleveraging and margin pressures. Its rough middle estimate of carry-related size was about JPY 40 trillion (USD 250 billion), explicitly subject to data gaps and measurement limitations. This is not a precise census of all yen-funded carry positions. The report describes spillovers and rapid stabilisation; it does not document the hypothetical contract terms in the exercises below.

For a wholly fictional one-year exercise, borrow JPY 1,000,000 at 1% and convert at 100 JPY per AUD into an AUD 10,000 asset paying 5% over the same year. Assume one year-end capitalisation, full redemption, no default, no forward hedge and no fees, exchange spread or tax. The rates are invented terms, not Japanese/Australian policy rates or an available offer. At maturity the asset is AUD 10,500 and the debt JPY 1,010,000.

Fictional year-end conversion; result in the debt currency
JPY per AUDAsset value in JPYDebt repaymentResult before omitted costs
1001,050,0001,010,000+40,000 JPY
95997,5001,010,000−12,500 JPY
90945,0001,010,000−65,000 JPY

The unchanged-rate surplus is 4% of borrowed principal, not a return on unspecified equity. At 95, the AUD principal loses JPY 50,000 in conversion, AUD 500 interest is worth JPY 47,500 and loan interest is JPY 10,000: the net is −12,500. Break-even is 1,010,000/10,500 ≈ 96.1905 JPY per AUD, a decline of about 3.81%, not exactly 4%, because the rate change also affects the AUD interest. A further fictional JPY 5,000 year-end fee makes the 95-rate result −17,500 JPY.

An honest verdict — is it worth it

In a separate collateral assumption, keep JPY 100,000 of own funds outside the AUD asset, earning no interest. The borrowed nominal is ten times that collateral. Losses of JPY 12,500 and 65,000 are 12.5% and 65% of these own funds; a lender need not permit holding to year-end. Suppose the invented contract requires closure below JPY 20,000 net collateral. At mid-year, a rate of 92 JPY/AUD, principal-only asset redemption and 0.5% loan interest leave 100,000 + 10,000 × 92 − 1,005,000 = JPY 15,000. The condition is met and own funds have fallen by JPY 85,000. A later rate recovery to 100 cannot restore the terminated exposure’s year-end surplus. Actual valuation, collateral and early-redemption terms require the real contracts.

Currency, funding, liquidity and counterparty risks need separate assessment. Different symbols sharing a funding currency may share important exposures; this does not imply identical returns or automatic failure of every diversified portfolio. Higher offered leverage alone does not change money profit or loss for the same exposure; increasing exposure relative to equity magnifies both. The carry trade glossary entry provides wider context. Positive financing is one component of a calculation, not a universal reason to enter or a guaranteed free addition to a directional trade.

What to do tomorrow

  1. Identify the contract first. Distinguish a cash loan and asset from a forward or retail CFD. For provider financing, record entity, instrument, units, long/short rate and calendar rather than assume daily positive credit.
  2. Compare financing income with exchange-rate risk. Divide the monetary loss from the specified price move by the positive net financing credited per day, using the same account currency. The result is an approximate number of days needed to offset that loss if the daily credit remained constant. A non-positive credit cannot offset it this way; swap rates, conversion rates and the position's value can change.
  3. Build a worksheet without opening a position. Recalculate the fictional asset and debt in their own currencies, then convert at several stated exit rates. Compare year-end and early-closure paths.
  4. Record funding and rate scenarios. Policy decisions, volatility, collateral requirements and funding costs can change the exposure. Known calendar dates do not establish the direction or size of an unwind.