||Ask Dr. Don
FDIC insured foreign currency
Dear Dr. Don,
I'm thinking about buying currency or
a $10,000 CD (FDIC insured) in either New Zealand dollars or South
African Rands. The return is 5.06 percent or 12.36 percent, respectively.
If the American dollar slips, at maturity (three months) I've got
a great return, right?
Just buying currency doesn't make sense -- you have to put
that money to work. Some U.S. financial institutions do offer Federal
Deposit Insurance Corp. insured certificates of deposit that are
denominated in foreign currency. The FDIC insurance protects you
against the bank's insolvency, not against the currency risk.
When you deposit $10,000 U.S. into a foreign-denominated
deposit, the deposit is assigned a value in the foreign currency.
The interest rate that you earn is based on the deposit amount,
the nominal (stated) interest rate and how frequently interest compounds
in the account. The more frequent the compounding the higher the
annual percentage yield.
You may earn the published returns or higher if the
currency appreciates against the dollar but you have to keep in
mind that the currency risk isn't insignificant. The best estimate
of the conversion rate at some future point in time is the forward
rate for that currency. Foreign exchange rates reflect the difference
between two countries' interest rates and inflation rates, so you're
not outfoxing the market when you put your money to work in foreign-denominated
You'll also be converting back to dollars at the bank's
"buy rate" which is lower than its "sell rate"
for the currency. That means that you'll pay the bank's spread on
your foreign exchange transactions.
one of the banks offering this type of CD, states on its Web site
that it typically executes foreign exchange three-quarters of one
percent away from the traded spot rate at the time of conversion.
-- Posted: March 24, 2003