The interest rate in Japan is 2%. It is 3% in the U.S. To implement a carry trade strategy an investor would:

A. borrow Yen in Japan, convert it to be $ and invest it in the U.S.
B. borrow $ in the U.S. , convert it to be Yen and invest it in Japan.
C. Invest Yen in Japan first, and later use forward contracts to convert Yen into $.

Correct Answer: A

One of the most popular carry trades is to borrow money in Japan and use it to invest in other countries. This has been fueled by a low Japanese interest rate. However, currency carry trades bear the risk of changing exchange rates. In this example, the investor could potentially lose money if the U.S. dollar fell sharply in value against the Japanese Yen.