Currency Carry Trade

It is an arbitrage mechanism in which one party borrow fund in one currency and trade in other currency. In this trader borrow funds from low interest rate country and invest in higher interest rate country and exploit the opportunity of difference in the interest rate of two countries.
Let’s take the example of Japan and India. In Japan the interest rate is 0.50% and India the interest tare is about 8%. Arbitrager can borrow funds in YEN from Japan at the rate of 0.50% and convert that funds from YEN to RUPEE and then buy Indian stocks or bonds which can give return more than or equal to 8%. These types of trade are funded by leveraged fund, the gains or losses are huge, so it is very risky trade too.
The main issues of concern in these types of trade are change in exchange rate and change in interest rate. We have seen the small crash in March 2007, when there was an appreciation in YEN and central bank of Japan Had increased the interest rate from 0.25% to 0.50%, those days trader were reversing their YEN Carry Trade. They were selling their long position in Equity and bond market because:
1-They had to pay more DOLLARS against a YEN.
2-Cost of Borrowing has been increased.