What it means
Carry is the difference between what an investment pays and what it costs to hold. If you borrow money at 4% to buy a bond that yields 5.5%, you earn a 1.5% margin every year before any change in the bond's price.
When that margin is above zero the trade has positive carry. The idea matters because it changes the maths of waiting.
A trader with positive carry collects income each day, so a flat market still produces a profit. A trader with negative carry pays to hold the position and needs the price to move in the right direction just to break even.
Carry appears in many markets. In bonds it is the coupon or yield less the repo or borrowing rate, in currencies it is the interest rate gap between the currency bought and the currency sold, and in commodity futures it comes from the shape of the futures curve.
Property investors talk about it too, when rent exceeds the mortgage interest. Positive carry is not free money.
The income is compensation for risk, such as the risk that the borrowed funding becomes more expensive, that the currency falls or that the borrower defaults. Many carry strategies earn steady small gains for long stretches and then lose a great deal in a sudden reversal.
Finance teams should therefore look at carry together with price risk. A trade with positive carry and a large chance of a sharp price fall may have a worse risk-reward balance than one with no carry at all.
Carry is also measured against alternatives. A treasurer deciding whether to hold surplus cash in bonds compares the yield with the cost of the short-term borrowing that might be needed if the cash is called back.
If the gap is only a few tenths of a percentage point, the carry may not pay for the price risk and the effort of managing the position.
In practice
Real-world examples.
Example
A hedge fund borrows in a low-interest currency and invests in a higher-yielding one. The interest gap of 2% on a $20,000,000 position produces $400,000 a year, provided the exchange rate holds steady.
Example
A landlord buys a flat for $400,000 with a mortgage, and the rent covers the mortgage interest with $3,000 a year to spare. The property has positive carry even before any rise in its value.
Example
A commodity trader buys a futures contract for a metal whose market is in backwardation, meaning the future price is below the spot price. The contract rises towards the spot price over time, so the trader earns carry as it matures.
Formula
Calculation
Carry = Yield on the asset - Cost of funding the asset
Annual carry income = Position size x Carry
A trader buys a $10,000,000 corporate bond paying a yield of 5.5% a year and funds it by borrowing at 4.0%.
Carry = 5.5% - 4.0% = 1.5%.
Annual carry income = $10,000,000 x 0.015 = $150,000, which is about $12,500 a month if prices do not change.Case study
Seen in the real world.
Tidewater Treasury is a fictional corporate treasury team that borrowed short term at 3.5% to hold a $15,000,000 portfolio of medium-term bonds yielding 5%. For a year the positive carry of 1.5% added about $225,000 to the company's earnings.
Then short-term borrowing costs climbed to 5.5% within two quarters and the carry turned negative. In this illustrative case, the team sold the portfolio and learned that carry depends on funding costs staying low, so they started stress-testing the trade for a 2% rise in borrowing rates before they entered it.
The lesson the group took was simple: carry is a reward for taking risk, not a replacement for it. They kept a smaller bond holding funded from retained cash instead of borrowing, so that the portfolio would earn income without depending on cheap short-term loans. The board also asked for the funding cost to be reported alongside the bond yield every month.
Watch out
Common mistakes.
- Treating positive carry as guaranteed profit, when it is the reward for taking risks that can cause larger losses.
- Counting the yield on the asset but forgetting funding costs, fees and hedging costs.
- Assuming carry stays positive, when changes in funding rates can reverse it quickly.
Questions
People also ask.
What is the opposite of positive carry?
Negative carry, where holding the position costs more than it earns, so the investor needs the price to move favourably to profit.
Does positive carry apply only to traders?
No, businesses and property owners meet it whenever the income from an asset exceeds the cost of the money used to hold it.
Why do carry trades sometimes lose heavily?
They often bet on stability, so a sudden shock can cause prices to move against many investors at once, and forced selling then makes the losses worse.
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