A financial bicycle (or Carry Trade) is a strategy that takes advantage of the difference in interest rates between two currencies or financial assets.
The basic idea is to borrow in a currency with a low interest rate and invest that money in a product or asset that offers a higher interest rate, with the goal of earning the difference, known as carry.
How a financial bicycle works
The typical strategy involves taking out a loan in a currency that has low interest rates, such as the Japanese yen (JPY), and then converting that money into a currency with a higher interest rate, such as the US dollar (USD).
Then, the money is invested in assets that generate a higher return, such as US Treasury bonds or similar investment products.
For example, if you borrow yen at an interest rate of 0% and invest it in a product that pays 5.5%, you earn that difference, minus associated costs or fees.
Why do investors use this technique?
The financial bicycle is attractive because it allows for profit generation from the difference in interest rates without the need for the investment value to increase.
For this reason, it is a common strategy among major market players, such as hedge funds and financial institutions.
Additionally, many investors use leverage, meaning they borrow more money than they have, which can increase profits but also losses.
Examples of financial bicycle operations
Yen-dollar: For years, investors borrowed in Japanese yen, which has very low interest rates, and then invested in dollar-denominated assets that generated higher returns. This operation worked well as long as the interest rate between both currencies remained stable.
Emerging markets: Another variant of the financial bicycle involves borrowing in currencies with low interest rates and then investing in currencies or bonds from emerging markets, which offer higher returns. However, these markets can be more volatile, and the risks are greater.
Risks of financial bicycle operations
Although financial bicycles can be profitable, they also carry SIGNIFICANT risks:
Currency risk: If the currency in which you took the loan appreciates against the currency in which you invested, you could lose money when converting it back. For example, if you borrow yen and the yen strengthens against the dollar, you will lose money when repaying the loan.
Interest rate risk: If the central bank of the currency you borrowed from raises interest rates, your borrowing costs will increase, reducing your profits. The same happens if the central bank of the currency in which you invested lowers interest rates, which would decrease your returns.
Impact of market conditions
Financial bicycles work best in stable and optimistic markets, where interest rates and currency values do not fluctuate drastically.
However, in unstable markets or during economic uncertainty, such operations can become very risky.
An example of this was in 2024, when the Bank of Japan unexpectedly raised interest rates, causing a sharp increase in the value of the yen.
Many investors began to close their financial bicycle operations, causing a massive sell-off of assets and destabilizing the currency markets.
* Financial bicycles can be a way to take advantage of differences in interest rates between currencies or assets if you are aware of what you are doing, as it is a complex strategy that involves significant risks, especially in volatile markets.
To succeed with this technique, it is essential to have a deep understanding of global markets and currency movements, making it more suitable for very experienced investors or institutions with the necessary resources to manage risks without ending up pursued by some bank or government.
That is, if you ask me, stay away from using this strategy.
