Have you been receiving marketing letters from banks ? There's a new product that they have been promoting these days. At this low interest period, there's a new deposit plan (US Dollar) that offers much higher interest than what you get from the normal fixed deposits, say, 8%. Wow ! That looks attractive right ? All you need is to lock in to a fixed exchange (eg. USD/AUD) with the bank on the maturity date of the deposit. On the maturity date of the deposit, if USD weakens against AUD and the market rate falls below the pre-determined exchange rate, you will receive your principal plus the interest in USD. On the other hand, if USD strenghtens against AUD, you will receive your principal plus interest in AUD.
So, what's the catch ?
This product is similar to shorting a put option. Your maximum gain is 8% and you possible maximum loss from this investment is the whole amount of your deposit.
The banks are misleading you in the exchange rate risk that you will be exposed to.
Let's say, you have deposited USD 10,000 and will recieve an interest of 8% in a year and you are locked into an exchange of 0.5 USD/AUD.
When your deposit matures, if the AUD drops drastically below the pre-determined rate (eg. 0.1 USD/AUD), you get your principal plus 8% interest, which is 10000 X 1.08 / 0.5 = AUD 21,600. When you exchange your AUD back to your domestic currency (USD), you will get only 21600 X 0.1 = USD 2,160. In the end, you lose USD 7,840 !!!!
On the other hand, if you are really lucky, the USD strengthens on maturity, no matter how stong it goes, you will get your 8% interest.
So, will you still go for such investment ?
posted by YY at
6:40:00 AM
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