Currency Carry Trade
Investopedia Commentary
It's like free money, right? Well, not quite. The big risk is the uncertainty of exchange rates. Remember, you've still got to pay back the money in a foreign currency. If your domestic currency falls in value relative to the currency you borrowed, then you run the risk of losing money. Also, these transactions are generally done with a lot of leverage, so a small movement in exchange rates can result in huge losses unless hedged appropriately.
An example of a "yen carry trade" is borrowing 1,000 yen from a Japanese bank, exchanging the funds into U.S. dollars and buying a bond for the equivalent amount. Assuming that the bond pays more than the amount you must pay the bank for borrowing the funds, and the exchange rate does not move adversely, you will earn a profit.
Related Links
Floating And Fixed Exchange Rates
Trading the Odds with Arbitrage
Advanced Bond Concepts
See also: Arbitrage, Bond, Currency, Exchange Rate, Fixed Income Security