How does the carry trade strategy generate profits?

The carry trade strategy generates profits primarily by exploiting differences in interest rates between two currencies. In a typical carry trade, an investor borrows funds in a currency with a low-interest rate and invests in a currency that offers a higher interest rate. The profit comes from the difference or "spread" between the interest earned on the investment and the interest paid on the borrowed funds.

This strategy can be quite effective, especially when there is stability in currency values, allowing the investor to benefit from both interest rate differentials and potential appreciation of the investment currency. Successful carry trades often occur in environments where higher interest rates are sustained and exchange rate fluctuations are manageable, enabling traders to lock in gains from both sides of the trade.

By focusing on the interest rate differential, the carry trade can yield significant returns, especially in a landscape where investors seek to maximize their yield on capital.