Profit Now From Currency-Linked Certificates of Deposit
Author : Thomas Hertog
The good news is that we live in a global economy and our savings strategies and investment options are beginning to reflect this reality. Because of these global opportunities we are no longer restricted to saving or investing in one currency, the U.S. dollar (USD).
While the U.S. economy continues its agonizing and tentative recovery, other countries are rebounding more quickly from the global slowdown of 2009 and 2010 and are showing signs of growth and expansion even as the U.S. struggles to regain a solid footing. This year several countries have experienced strong appreciation of their currency against the USD like China up 6.5%, Australia up 15%, Singapore up 11%, and Canada up 6%. This could be an opportunity to invest in a currency-linked certificate of deposit (CLCD). A CLCD is a certificate of deposit that provides a performance return based upon the change in valuation of an underlying single currency or a basket of currencies. There may be a nominal interest rate that returns income as well.
There are several important issues to be aware of when investing in a CLCD. First, although the CD is FDIC insured, it is only insured if the bank issuing it fails or becomes insolvent. The FDIC program does not cover loss of value due to currency fluctuation. There is a liquidity risk that may result in the CD having less value or no value in the event that you need to access your funds before maturity. Most CLCDs have a participation rate (similar to equity-linked certificates of deposit) that determines what percent of the currency performance return the investor gets. The most attractive CLCDs offered use 100 percent – meaning that if the currency increases in value by 15 percent over the term of the CD that you will receive the full 15 percent. There are a few ‘exotic’ CLCDs that actually offer a participation rate of up to 120 percent. An equity-linked CD may have an interest cap, but very few CLCDs include an interest cap because the rate of interest is not the primary value driver of the investment. It is usually no more than 0.5 percent annualized.
Let’s take an example. If you were to purchase a CLCD with a face value of $ 100,000 USD that is linked to the Swiss franc (CHF) it might look like this. The CHF which presently trades at 1.0793 to USD and has traded in the past 12 months as high 1.4100 to USD. If you buy the CLCD today the exchange rate is locked in at the current rate of 1.0793. When the CLCD matures in 12 months the prevailing rate will be used to determine the performance return. If for example the CHF resumed its high of 1.4100 at the time of maturity, the rate of return would be 30.6 percent for 12 months. At full participation the investor would receive $ 130,600 USD when redeeming their $ 100,000 USD face value CLCD on year from now.
But the opposite can also occur. If one year ago you purchased a CLCD linked to the Indian Rupee (INR) you would have purchased at an exchange rate of approximately 0.0223 to USD. Today, the INR trades lower at 0.01998 or 10.4 percent less. When you redeem your $100,000 USD face value CLCD you would receive only $ 89,600 USD. The loss of value of $10,400 would not be covered by FDIC insurance because the bank did not fail or become insolvent. The loss was due the change in currency valuation.
It should be clear from our discussion here that CLCDs are more complex than ELCDs due to the volatility of foreign exchange rates. CLCDs are available for terms of 3 months to 5 years and can be linked to a single currency or customized to contain a basket of currencies. While both CDs function in a similar fashion, behavior of the underlying currency or index can be very different and subject to extreme variation over the term of the CD. You should read all materials with care and determine if the investment is suitable for you.
Banks that offer currency-linked certificates of deposit