In the simplest version, carry trade may look like this: an investor takes a loan at 9% and invests this money at 12%. The difference of 3% from the capital involved will be the investor's profit.
This is how, without investing a penny from his pocket, an investor can make a profit, in fact, "out of thin air." But it's not that simple. Any investment carries risks. In the above example, the investor fully assumes the risk of investing in an asset with a yield of 12%. In case of its implementation, it will remain owed the bank the borrowed amount, and even with interest.
As you know, in the financial market, the return on investment is closely related to risk. The higher the risk of an investment, the higher the return it provides to the investor. Thus, from the point of view of the risk / reward ratio, a scrupulous situation is obtained: the investor receives 3% for the risk, which in the market is estimated at 12%.
It is fair to say that the market valuation of the risk premium is not always fair. Markets are not always efficient, although they strive for this state. But in any case, during carry trade operations, the investor needs to choose the least risky assets for which the probability of losses on the investment horizon tends to zero.
Therefore, in practice, the main objects of carry trade are government bonds of different countries of the world. At the same time, opportunities for earning open up only if the investor borrows and invests funds in different currencies.
Inflation and interest rates vary in different markets. Real profitability in a country is simply defined as the nominal rate minus inflation. For example, if a government bond is traded with a yield of 7%, and the inflation rate in the country is 4%, then the real rate will be 7-4 = 3%. If in another country an investor has the opportunity to borrow money at a lower real rate, for example, 1%, then there is an opportunity for carry trade.