Dual Currency Deposit: Overview and Examples (2024)

What Is a Dual Currency Deposit?

A dual currency deposit (or DCD) is a financial instrument structured to help a depositor take advantage of relative differences in two currencies. It allows a bank customer to make a deposit in one currency and withdraw the money in a different currency if it is advantageous to do so. These products are also known as dual currency products or dual currency services.

The DCD combines a cash or money market deposit witha foreign exchange option. Because of the currency risk, dual currency deposits offer higher interest rates.

How a Dual Currency Deposit Works

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 dualcurrency deposit is a derivativewith 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After currency repatriation, the moment the deposit is withdrawn back it is possible for the investor to get back less than the initial investment, even after interest is factored in.Therefore, it is better to think of it as an investment product with all associated risks.

Dual currency deposits are typically short-term products for investors desiring exposure to two currencies. The principal is not a protected investment product. Both parties must agree to terms including investment amounts, currencies involved, maturity, and strike price.Interest is earned in the originating currency, butthe principalhas the possibility of a payment in the second currency, should the counterpartyexercise the option.In essence, thisis a deposit that creates aforeign exchangerate risk for the investor,not unlike that of acurrency swap.

Example of a Dual Currency Deposit

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 maybe convertedto a different currency if the counterparty chooses to exercise their option. If that currency is one the investor does not mind holding, thenit 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 countryB but knows that short-term interest is more favorable in country A, they will preferto invest their money in countryA 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 witha dual currencydeposit 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 ofCountry 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.