Dual Currency Deposit

I visited a bank recently and was introduced to Dual Currency deposit.

HOW IT WORKS

Firstly, customer has to choose two currencies. For simplicity, let’s assume SGD and AUD.

For illustration,

Current exchange rate is S$1.16 per AUD.
Established strike price is S$1.2 per AUD.
Contracted SGD interest rate : 0.75%
(This rate is higher than prevailing SGD interest rates).

At a pre-determined date, say, 1 month later, if the exchange rate goes up to S$1.25 per AUD, I'll get the deposit back in SGD (the weaker currency). However, the bank will compensate me with a slightly better SGD interest rate (of 0.75%).

If exchange rate goes down to S$1.1 per AUD (that is, AUD depreciated), I'll get my deposit back in AUD at S$1.2 per AUD, which is the strike price.

MY CONVERSATION WITH THE BANKER

Me : What happens if AUD crashes to, say S$0.95/AUD?
RM : Don’t worry, this is very unlikely.
Me : What if it really happens?
RM: wlll, then you just continue holding in AUD. You can plan for a holiday in Australia. Or hold it in an AUD account and wait for it to climb back up. One good thing about AUD is that the interest rate is much higher than if you were to hold in SGD.
Me: Errm.. but I still don’t feel comfortable.
RM : If you are worried, you can just opt for a shorter tenure, say 2 weeks. That should be quite safe.
Me : Errm.. ok. Can you tell me what is the maximum risk that I am exposed to? Can I lose everything?
RM: No, don’t worry. Unless AUD loses all its value, which is not possible right?
Me : Hmmm.. let me go home and think about it.


VARIOUS SCENARIOS

Investment Amount : S$10,000
Current exchange rate is S$1.16 per AUD.
Established strike price is S$1.2 per AUD.
Contracted SGD interest rate : 1.00%

SCENARIO 1 : AUD APPRECIATE TO ABOVE THE STRIKE PRICE AFTER 1 MONTH (SAY, S$1.25/AUD)
I would get back my S$10,000 +S$8.22* = S$10,008.22
[*interest earned after 1 months at 1.00%]

SCENARIO 2 : NOTHING HAPPENS, THAT IS, EXCHANGE RATE DID NOT MOVE MUCH.
I would get back my S$10,000 +S$8.22* = S$10,008.22
[*interest earned after 1 months at 1.00%]

SCENARIO 3 : AUD DEPRECIATE TO ABOVE THE STRIKE PRICE
I would get back in AUD at pre-determined exchange rate of S$1.2 per AUD, that is, A$8,333.33

If the prevailing exchange rate is S$1.1 and I need my SGD back, then I would only get back,
= A$8,333.33 x S$1.1/AUD = SG$9,166.
Net Loss of S$10,000 – S$9,166 = S$834.

If I were to continue holding my deposit in AUD, the 6% in AUD interest rate would take me more than a year to recoup back my loss.


MY THOUGHTS
- In fact, the customer is as good as selling an option on the alternate currency at the exercised (or strike price) and the "additional interest" is merely the option fee earned. The bank is very likely to have either earned a certain portion out of the option fee or the bank could be taking the opposite side of the trade unless it hedges it out in the market.



Does it make sense for me to invest in such products?
- Only if i've some uses for AUD currency, e.g. business needs, or if I have children who are studying in Australia, if I really do have plans to tour Australia - which means I don't mind holding on the alternate currency.
- However, if one is buying this product solely for investment gains, my personal view is that you are better off, engaging in direct FX trades or buying /selling FX options yourself, rather than getting into a structured product.

On dual currency investment, my gain would have been “capped” while my losses would have been unlimited”. [Payoff is quite similar to selling a put option].


Cap = my gain is limited to the contracted interest rate (over the existing prevailing interest rate).
Unlimited loss = I do not know how much the exchange rate will ultimately be and that is the risk I am taking.

Just my two cents worth.