As per when carry trades work and when do not, a trader stands to form a profit of the difference within the interest rates of the two countries as long because the rate of exchange between the currencies does not change. Many professional traders prefer currency carry trade due to the gains that can become very large when leverage is taken into consideration. If the trader in our example uses a standard leverage factor of 10:1, he or she can stand to form a profit of 10 times the rate of interest difference.
The funding currency is that the currency that’s exchanged during a currency carry trade transaction. A funding currency typically features a low rate of interest . Investors borrow the funding currency and take short positions within the asset currency, which features a higher rate of interest The central banks of funding currency countries like the Bank of Japan (BoJ) and the U.S. Federal Reserve often engaged in aggressive monetary stimulus which results in low-interest rates. These banks will use monetary policy to lower interest rates to kick-start growth during a time of recession. As the rates drop, speculators borrow the money and hope to unwind their short positions before the rates increase.