Dual Currency Deposit is an investment product commonly offered in the world of Private Banking. It has many other names – Extra Deposit, Premium Deposit, Maxi Yield Deposit etc. Dual Currency Deposit is a very popular product that generates much higher return than normal bank deposits. These returns can often be in excess of 10% p.a. This is a very attractive return in this current market environment when normal bank interest rate only offers around 1% p.a.
Dual Currency Deposit has a lot of similarities to a normal bank fixed deposit like a fixed maturity date, and a fixed interest rate. It even uses the term “deposit”. However, Dual Currency Deposit is not a deposit at all. It is strictly an investment product with very high risks associated with it.
Lets look at a simple example of Dual Currency Deposit before we dwell into the risks associated with it. Say, you have USD 300k placed in deposit. You are familiar with Australia and the Australian Dollar. You come across an advertisement in a reputable bank with the following key points:
Earn a Higher Return than Bank Deposit
Short Term investment. Term can be two weeks, one month, two or three months.
On the day of investment you choose the alternate currency (in this case Australian Dollar) which you want to receive your investment at maturity
Assume the currency Australian Dollar to US Dollar exchange rate is 0.9000
You will receive you deposit back in either US Dollar or Australian Dollar at a predetermined level
The predetermined level is 0.9200
The returns offered got your attention. The ad states with the above conditions, you will receive 12% p.a. for placing your deposit in this investment. However, you were in a rush and had to walk away.
Risks Associated with Dual Currency Deposit
On the surface the product sounds simple enough. Apart from receiving in US Dollar or Australian Dollar, everything else sounds like a normal fixed deposit. Dual Currency Deposit is a derivative instrument. You know the investment products (Derivatives) that Warren Buffet said he won’t invest in because he cannot understand them. Well, this is one of those products. Dual Currency Deposit has embedded Options in it. Option is a derivative instrument that is very complex and difficult to understand. Without going into too much detail about option, I like to highlight one of the risks of this product – Foreign Currency Risk.
Foreign currency moves much faster than most people realizes. During the 2008 financial crisis, it is not uncommon to have foreign currency moves more than 20% in a period of two weeks. This is the case with the Australian versus US Dollar exchange rate. Imagine our poor investor thinking they placed their hard earned money into a “deposit” and left it for two weeks and return to it only to realize that they suffered a major loss of 20% on their capital. Because the 12% they earned is on a per annum basis, they will only receive around 0.46% for the two weeks. That is cold comfort when compared to the losses they incurred on the exchange rate. Although this example I have given is extracted from an extremely volatile period, exchange rate is still subject to normal fluctuation in excess of 5% over a period of two weeks.
There are other risks associated with Dual Currency Deposit. Visit http://plainfinance.blogspot.com/ to see more articles relating to Dual Currency Deposit. Benjamin Finance is the author of this blog. He works in the banking and finance field. His aim is to raise financial literacy via his blog.