Five Cents Ten Cents

Wednesday, August 29, 2007

How to buy foreign currency fixed deposits in Singapore

As part of my ongoing efforts in diversifying my investments and looking for higher yielding instruments, I started to invest in foreign currency fixed deposits with Maybank using iSavvy.

Fixed deposits (FD) vs. foreign currency fixed deposits (FCFD)
We all know what fixed deposits or time deposits are. These are monies we deposit with a bank for a fixed tenure (time period) for a fixed interest rate. Fixed deposits are relatively safe instruments as unless the banks collapse, your principal and interest are much safer compared to other investments such as stocks and shares (equities) or unit trusts (mutual funds).

In return for this relative safety, the returns or the interest earned from fixed deposits are very low. On average, they hover as low as 1% plus to 2% plus. There is always a risk-return tradeoff in investments. Generally, safer assets such as fixed deposits give you a lower return compared to stocks and shares, derivatives (options, futures), commodities etc.

However, there is a type of fixed deposit that can potentially give you a much higher interest than the 2% plus you are getting and that is the foreign currency fixed deposit. What is a foreign currency fixed deposit that you can place with a Singapore bank? A foreign currency fixed deposit (FCFD) is similar to a singapore dollar fixed deposit in that you are also depositing an amount with the bank for a fixed tenure and for a fixed interest rate. However, the difference is that this deposit is denominated in a foreign currency.

Risks of foreign currency fixed deposits (FCFD)
Depositing in a foreign currency fixed deposit is available at most of the banks in Singapore. However, this type of fixed deposit is inherently riskier than the Singapore dollar fixed deposits. This is because exchange rates can go up and down during the tenure of the deposit. This can potentially cause your deposit to lose value if at the end of your FCFD tenure, the foreign currency depreciates or loses it value compared to the Singapore dollar. Conversely, if the foreign currency appreciates or gains its value compared to the Singapore dollar, your deposit and interest earned could gain in value.

Let us take an example to illustrate this risk.

Assuming you place a Australian dollar fixed deposit of AUD 10,000 for 12 months at an interest rate of 5%.

Principal in Australian dollar: AUD 10,000
Principal in Singapore dollar (at SGD/AUD : 1.20) : SGD 12,000
Interest earned in AUD at end of 12 mths: AUD 500

If you had put that same amount of Singapore dollars for 12 mths at 2% interest,
Principal in Singapore dollar: SGD 12,000
Interest earned in Singapore dollar at the end of 12 mths: SGD 240.

Scenario 1: Assume Australian dollar strengthens or appreciates against Singapore dollar (SGD/AUD: 1.30)
Interest earned in Singapore dollar at end of 12 months at 1.30 : SGD 650 (AUD 500 x 1.3)
Principal converted back to Singapore dollar at end of 12 months at 1.3: SGD 13,000
Principal + Interest in Singapore dollar: SGD 13,650

Under scenario 1, congratulations, you have made a better return of SGD 410 (SGD 650-240) over your interest and a exchange gain of SGD 1,000 (SGD 13,000-12,000). So you end up with a total return of 13.75% on your intial deposit of SGD 12,000 in the Australian dollar fixed deposit.

Scenario 2: Assume Australian dollar weakens or depreciates against Singapore dollar (SGD/AUD: 1.10)
Interest earned in Singapore dollar at end of 12 months at 1.10 : SGD 550 (AUD 500 x 1.1)
Principal converted back to Singapore dollar at end of 12 months at 1.1: SGD 11,000
Principal + Interest in Singapore dollar: SGD 11,550.

Under scenario 2, you realise you have made a better return of SGD 310 (SGD 550-240) over your interest. HOWEVER, you have made an exchange LOSS of SGD 1,000 (SGD 11,000-12,000). Your principal + interest exchanged back to SGD gives you SGD 11,550 or a LOSS of SGD 450! Hence, instead of enjoying a return of at least 2% if you had deposited in Singapore dollar fixed deposit or even 5% if the Australian dollar didn't move against Singapore dollar, you made a loss of 3.75%!

Therein lies the risk of FCFDs. The volatility of exchange rates during the tenure (time period) of your foreign currency fixed deposits can cause the typically higher interest of 5% to 8% on currencies such as Australian dollar, New Zealand dollar to be offset by the loss in your principal when you exchange back your foreign currency deposit to Singapore dollar.

Why do people still deposit in FCFDs given the risk?
Many investors still put in their monies into such FCFDs despite the risk because they recognise this risk and are willing to accept the volatility in return for higher returns. Others take up risk mitigating strategies. One such strategy that I have adopted is to invest in FCFDs when the exchange rate is relatively favourable, i.e. when Singapore dollar is relatively strong or when the foreign currencies have weakened relative to Singapore dollar.

Another strategy is not to exchange back your principal. Because it is the risk of the exchange loss on your principal amounts in foreign currency that can potentially wipe out all your additional interest earned on your FCFD compared to Singapore dollar FD, what I did was to earmark my FCFD for long-term investment and allow it to auto-roll or auto-renew. What this means is that I am deferring the possible exchange losses/gains to a later date because so long as I do not exchange the currency back to Singapore dollar, I will not suffer a gain/loss.

However, this is not 100% foolproof because if in the long term Singapore dollar appreciates against the FCFD currency, then I will still be hit by exchange losses in the future.

The only true way to mitigate this risk is to use derivatives to hedge yourself against the risk but this is outside of my scope as a small investor.

Invest at your own risks
What I have shared are just a way that I have diversified my portfolio by putting aside a relatively small portion into higher yielding assets. Currently Maybank's iSavvy foreign currency fixed deposits for 6 months in NZ dollar yields about 8%. This is 4x the average 2% interest you can get from Singapore dollar fixed deposits. This is risky because the New Zealand dollar fluctuates against Singapore dollar and hence this is not guaranteed returns.

I am prepared to hold for the longer term and only exchange it back if I need the cash or when the exchange rates are favourable. Please do your own homework and consult with professionals about the risk before investing as this is very much more risky if you do not have holding power or if the Singapore dollar is on a sustained rally against major currencies.

Consider your own risk profile and decide for yourself if this type of investment is for you.

Be well and prosper.

6 comments:

Anonymous said...

hi,

Thank u for writing this post. It answers some of the doubts which I have about FCFD. It is true that I am attracted to the higher interest rates which FCFD can offer as compared to Sing dollar FD. I feel like diversifying a part of my savings into FCFD, but am currently at 'war' with my parents over this issue. May I know which foreign currency are ur funds in? I am keeping my eye on Australian dollar 'cos it has been doing pretty well against S$ from the post-SARS period until now. Will you be writing more about using derivatives to hedge against the risk of FCFD?

ikijuf

PanzerGrenadier said...

Hi ikijuf

I currently have New Zealand dollar foreign currency fixed deposit. The interest is 8.4% for a 6 mth tenure.

I am currently looking into forward forex rates. It appears that RHB bank does have this service and I need to check with them on how it works. Will post more information when I have it. :)

Do consider the risks of foreign exchange going against you if you intend to take the principal out in singapore dollar.

Be well and prosper.

Anonymous said...

hi,

thanks for your entries, they have been useful in my learning of financial matters.

this current entry reminded me of something that i read in the papers, that japanese yen will appreciate sooner or later. what is your take on that?

thanks

yslim

PanzerGrenadier said...

hi yslim

Thanks for reading my blog! :)

I have absolutely no idea on how the yen will move as I do not monitor forex that closely.

My foray into specifically New Zealand Forex FD is because I was in Australia recently for a holiday and had a feel of how good the Australia/New Zealand economies were doing. Hence, i decided to take the risk and get into a currency where I think has more upside than downside given the large correction in its exchange rate vis-a-vis the Singapore dollar.

Be well and prosper.

jk said...

Hi panzergrenadier (Mr. Loh?),

Such a mouthful for a name! :P.
Great stuffs, btw what is "forward forex rates".

I did not do my homework well, and did not diversify my investment as well. Last time I put all/around 50k of S$ to US$ in order to take advantage of US high interest rate 4% plus.

Now, as the currency getting weaker against S$, it doesn't make quite a good of money for me. *I think I only earn S$ 2000 sgd, over the course of,... say, around 3-3.5 yrs?.

Zach said...

Hi, you definitely should have some knowledge of forex movements and projected trends for next few years before putting your money in FCFD as exchange rates move more than interest rates. One doesn't really need to use derivatives to hedge agst FCFDs as typical forex contracts leverage abt 1 mil USD per contract. It is used for hedging by large commercials and for speculation.

If one looks at a chart for USD/SGD, its been trending lower since 2005 with a slight uptick the past 2 weeks. What will be the USD trend in the next year ? What is the projected trend for the yen ? The truth is that no one knows for sure, but there are analytical tools (technicals)and fundamentals that pple use to project currency movements. Bottomline, don't just look at interest rates.