How Interest from Your Foreign Currency Fixed Deposit Affects Your Returns

Over the last couple of days while turning the idea over in my head of opening a foreign currency fixed deposit account, I’ve been looking up interest rates quite voraciously. To my surprise, and disbelief, the US dollar (US$), the Euro (€) and a couple others have such low interest rates that I’m wondering why anyone would want to open such an account with any of our local banks in the first place. Also, when coupled with the FOREX risk involved (refer to The Risk of Foreign Currency Fixed Deposits for a discussion on FOREX Fixed Deposits risks), it’s unbelievable anyone would find it worth the gamble.

That said, there was only one currency that stood out in terms of interest rates. The Australian dollar (A$).

Here are some figures pulled out from the relevant banks’ websites to illustrate this.

ICIC bank offers the best interest rates for their fixed deposit account for a 12mth period, with CIMB coming in second. However, CIMB offers more flexible deposit time periods and has the best rates other than the 12mth.

So with such high interest rates does this make it a good investment? Lets see.

Using ICIC bank’s interest rate of 6.59% p.a., a deposit of S$10,000 and an exchange rate of S$1.00 = A$0.90:

Conversion of S$10,000 into A$: S$10,000 = A$9,000

Interest gained after 1 year: A$9,000 x 6.59% = A$593.10

Total amount: A$9,000 + A$593.10 = A$9,593.10

Looks like a gain doesn’t it? But unfortunately, this doesn’t take into account foreign exchange risks. Take a look at these points.

1) If rates remain the same after a year, then converting A$9593.10 back into S$ will give us a total of S$10,659, a gain of S$659 or 6.59% as promised by the bank.

2) However, should the S$ rise in strength against the A$, a 10cent move upwards (i.e. S$1.00 = A$1.00) will result in your investment now being worth only S$9,593.10 or a 4% net loss of S$406.90 despite the interest paid.

3) On the flipside, a 10cent move downwards where S$1.00 = A$0.80, will result in your investment now being worth S$11,991.37. A nifty gain of almost $2000 or 20% profit.

If you’re a person who thinks that the upside must be twice that of the downside, then perhaps this investment might be something to put on your radar. However, do also consider the minimum investment amount and the buy/sell spread which I didn't mention. These vary from bank to bank. 

For me, I doubt I’ll be opening an account any time soon, at least not till I’ve set my other investment plans in motion. But once I do, I'll definitely consider this.

Cheerios!

~K

The Risk of Foreign Currency Fixed Deposits

We all know that the banks interest rates at 0.1% is rubbish. Even the fixed deposit interest rates are rubbish. So I've been tinkering with the idea of converting a portion of my funds to a foreign currency to be locked up in a fixed deposit account for the sake of portfolio diversification as well as to earn the higher interest rates. However, like all investments, this comes with their own risks. The most important of all is foreign exchange risks, where the original currency gains in strength to the foreign currency thereby resulting in a lower value of the original invested sum when the foreign currency is converted back. Confused? Don't be.

Here's an example to illustrate:
2010 S$1 = A$0.90
2011 S$1 = A$1.00
2012 S$1 = A$0.80

Therefore if you converted S$10,000 into Australian Dollars (A$) in 2010, you'd get A$9,000. In 2011 however, if you were to convert the same A$9,000 back into Singapore Dollars (S$), you'd wind up with S$9,000. But if you were to hold on to 2012, the A$9,000 would now have been worth S$11,250 instead.

So you can see from the above example how a simple shift of 10cents can drastically affect your invested amount.

Note that this is without any interest paid by the bank.

In my next post, I'll elaborate on how interest affects your deposit in the foreign exchange fixed deposit. But for now...

Ciaoz Amigos!
~K