Hong Life CalculatorsUnderstanding the carry trade calculator — concept and principle
This calculator shows the profit or loss of a currency carry trade: borrowing in a low-interest currency, investing in a higher-interest one and converting back at the end. It separates the interest carry from the exchange-rate effect and gives the break-even exchange rate, the return on your own capital and how far the target currency can fall before the trade loses money. Use it to understand currency risk.
How it is calculated
- Profit = B ÷ S₀ × (1 + i_target)^t × S₁ − B × (1 + i_funding)^t.
- B is the amount borrowed in the funding currency; S₀ and S₁ are exchange rates in funding units per target unit at the start and end.
- Interest carry = profit if the exchange rate stays at S₀.
- Exchange-rate effect = profit − interest carry.
- Break-even rate = S₀ × (1 + i_funding)^t ÷ (1 + i_target)^t.
- Return on capital = profit ÷ your own margin capital.
Costs, spreads and taxes are not included.
The principle
The trade earns the interest rate differential as long as the exchange rate does not move against it. Uncovered interest parity, a benchmark theory, says the high-yield currency should fall by about the interest differential, which would wipe out the profit. In practice, high-yield currencies have often not fallen that much on average, which is why carry trades exist; but they can fall sharply in crises, and losses then come quickly. The break-even rate is the exact depreciation that cancels the carry.
Worked example
Default inputs: borrow 10,000,000 at 0.5%, invest at 4%, rate 150 now and 145 at the end, 1 year, own capital 1,000,000.
- Converted: 10,000,000 ÷ 150 ≈ 66,666.67 target units; after a year at 4%: 69,333.33.
- Back at 145: 69,333.33 × 145 ≈ 10,053,333; loan repayment 10,000,000 × 1.005 = 10,050,000.
- Profit ≈ 3,333 (funding currency), a 0.3% return on capital.
- Interest carry at an unchanged rate = 350,000; exchange-rate effect ≈ −346,667.
- Break-even = 150 × 1.005 ÷ 1.04 ≈ 144.95, so the target currency can fall about 3.37%.
| Exchange rate now (funding units per 1 target unit) | Profit or loss (funding currency) |
|---|---|
| 37.5 | 30,163,333 |
| 75 | 10,056,667 |
| 112 | 3,354,444 |
| 150 | 3,333 |
| 188 | -2,007,333 |
| 225 | -3,347,778 |
| 300 | -5,023,333 |
How to read the result
A small move in the exchange rate can erase most of the carry, as here: a 3.3% fall left only a tiny profit. Because the position is borrowed, results on your own capital are magnified in both directions. Compare the expected currency move with the interest differential (3.5% here) before taking risk.
Common mistakes
- Quoting the exchange rate the wrong way round (target per funding unit).
- Ignoring the cost of the loan in the funding currency.
- Treating the interest carry as guaranteed profit.
Frequently asked questions
What is a carry trade?
Borrowing in a low-interest currency to invest in a higher-interest one, earning the rate differential.
What is uncovered interest parity?
The idea that a currency's expected depreciation equals the interest differential, leaving no expected carry profit.
Why do carry trades sometimes collapse quickly?
When many traders unwind at once, the funding currency can jump, causing large losses.
Sources: M. Cavallo, "Interest Rates, Carry Trades, and Exchange Rate Movements", FRBSF Economic Letter 2006-31 (17 Nov 2006)