Understanding Dual Currency Deposits: Benefits, Risks, and Examples

What Is a Dual Currency Deposit?

A dual currency deposit (or DCD) is a short-term financial instrument that combines a cash or money market deposit with a foreign exchange option. It allows a depositor to place funds in one currency and withdraw them in another if market conditions make it advantageous.

Because DCDs involve currency risk, they typically offer higher interest rates than standard deposits. However, there is a possibility of losing some principal if exchange rates move unfavorably.

Key terms, such as the investment amount, chosen currencies, maturity date, and strike price, are agreed upon upfront, making it essential for investors to fully understand the risks and conditions before committing.

Understanding the Mechanics of Dual Currency Deposits

Despite its name, a dual currency deposit is not a deposit in the sense that capital is at risk. A dual currency deposit is a structured product composed of a fixed deposit and an option. So the dual currency deposit is a derivative with a combination of a money deposit and a currency option. The investor will use this product in hopes of capturing higher yields from better interest paid by one currency compared to the other, and by relative changes in currency. However, it is also true that the investor must be ready to accept higher risks that those same changes in currency work unfavorably.

After currency repatriation, the moment the deposit is withdrawn back it is possible for the investor to get back less than the initial investment, even after interest is factored in. It's better to view it as an investment product with associated risks.

Dual currency deposits are usually short-term products for investors who want exposure to two currencies. The principal isn't a protected investment. Both parties must agree on terms like investment amounts, involved currencies, maturity, and strike price. Interest is earned in the original currency, but the principal might be paid in a second currency if the counterparty exercises the option. Essentially, this deposit creates a foreign exchange rate risk for the investor, similar to a currency swap.

Illustrating Dual Currency Deposits With an Example

The selling point for dual currency deposits is the chance to earn significantly higher interest rates. The risk for the investor is that the investment may be converted to a different currency if the counterparty chooses to exercise their option. If that currency is one the investor does not mind holding, then it is not a substantial risk to take.

However, the risk is that the investment may still need to be converted back to the home currency at a future date with a less favorable exchange rate. The investor can choose to hold these funds in the foreign currency in hopes that the exchange rate will eventually move in their favor, or exchange them immediately, perhaps at a loss, to free up the funds for future trades.

If an investor lives in country B but knows that short-term interest is more favorable in country A, they will prefer to invest their money in country A where they may realize better earnings. However, if the investor feels the exchange rate for country A's currency will move against them over the life of the deposit, the investor may hedge against that risk with a dual currency deposit option. At maturity, the counterparty will repay the investor in their home currency. The downside, of course, is if the exchange rate moves in the opposite direction, it would be more profitable to remain in the currency of Country A and repatriate the funds after the deposit matures. 

While the investor still receives the same amount contracted in the deposit contract, essentially creating a floor under its value, a problem arises when it is time to repatriate those funds. The exchange rate may be even less favorable than at the outset of the deposit, and the investor will receive less than they might have otherwise received, maybe even less than the amount invested.

The Bottom Line

Dual currency deposits (DCDs) offer higher potential returns by combining a fixed deposit with a currency option, letting investors deposit in one currency and possibly withdraw in another. However, these short-term products carry significant currency risk, meaning unfavorable exchange rate movements can result in receiving less than the original investment.

DCDs are not protected investments, and terms such as maturity, strike price, and currencies are set upfront. While they often provide better interest rates than traditional deposits, they are speculative products suited for investors comfortable with currency market volatility and the possibility of needing to convert funds back at less favorable rates.