How does the carry trade work?

Hi
Anyone know of any text books, or any books, or any journals that can help a novice to understand and operate the Carry Trade? Grateful for titles and publishers. Thank you.

The carry trade is when an investors borrows in one currency such as the Yen which carries with it a 0.5% interest rate and uses that money to invest in something with a better return. For example, a US investor sells the Yen against the US Dollar and with margin rates of 1%, he is using only $1000 to borrow $100,000 worth of Yen for a period of time. He then turns around and buys the New Zealand Dollar against the US Dollar and receives an interest rate of 7.5%, making a net of 7%. But since he only invested $1000 to borrow that $100,000 worth of Yen, his return is much higher than 7%.

Sort of an equivalent to the carry is if you found an investment that would pay you 12%. You take out a home equity loan on your house at 6% and use the money for that 12% investment.

Now, as for the carry trade causing stocks to go down, it's actually the other way around, the downfall of stocks is causing the carry trade to unwind. What start the whole thing is that the Chinese government felt the 11% growth in their economy last year was too high and wanted to make it more reasonable (8%). They instituted some rules to cause that slowdown to occur. Investors in the high-flying Chinese stock markets were worried about how a slowdown would affect their stock gains and started taking profits. It snowballed and became a full-fledged correction. Other world markets saw this, felt the slowdown would affect the rest of the world and they started selling.

This slowdown and the effect it might have on commodities caused an effective increase in risk in the carry trade. Traders that were unwilling to carry that extra risk started closing out their carry trades. As some started doing it causing the Yen to increase in value (they had to buy the yen to close out their Yen-short position). When they did this, they had to also close out their offsetting trade, usually in either the Australian Dollar or New Zealand Dollar causing those currencies to go down. Same thing happened with the Euro and the Pound. With Canada being a large producer of commodities and with the fear that commodities would take a hit, the Loonie (Canadian Dollar) declined.

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Support Resistance

Word of advice, words I wish I read before I started the carry trade deal about three years ago... dont automatically use FX brokers. The spreads are very often pathetic in comparison. For instance, you can use an ETN purchased over the U.S. stock exchanges and get 4.5% on your position whereas with Oanda, who are very competitive in terms of interest rates (or, they used to be, cant say that for sure now) were only at about 2.8% on the exact same position. Sure, you cant leverage like you can with the stock broker like you can the FX broker, but... you really shouldn't be leveraging into a position you are going to "carry" anyway.