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FDIC insured foreign currency deposits

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?
Sally Sovereign

Dear Sally,
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.

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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 deposits.

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.

Everbank, 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

Read more Dr. Don columns
See Also
Investing in foreign government bonds
Foreign account requirements
Financial advice glossary
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