Dual currency investment

A friend was asked by her superior to research on dual currency investment. It stimulates my mind, where I am missing on my way towards learning. I realised i have no learnt a new thing in the past few months, making up my mind to start up to reading.

Dual currency investment, gives an investor an opportunity to earn higher returns compared to a regular fixed deposit. This is the definition given by a banker, usually, who persuades client to make investment on it. It is a linked-currency product. Investor always has the flexibility to choose a base currency and a alternative currency for his investment. Investors are eligible to receive his investment interest plus interest earned in base currency or alternative currency. Investment tenor could be 1 week to 6 months.

However, the actual product is very complex, and not easy to understand.

A dual currency investment involves two currency an investor choose and the use of spot rate and target rate (conversion rate). An investor is paid by his principal and interest earned in base currency if the prevailing spot rate does not go beyond its target rate, and is paid in alternative currency if the prevailing spot rate goes beyond its target rate.

The explanation above might be confuse, to make it simple, we use a simple example.

Today (19th April 2012), GBP/MYR is trading at 4.910. You believe the rate might be fluctuates, probably depreciates, but will not fall below 4.810 (1000 pips away from spot rate).

What is the key information that determines your returns?

Base currency: MYR 5,000

Alternative currency: GBP

Spot rate: 4.910

Conversion rate: 4.810

Trade date: 19th April

Value date: 21th April

Fixing date: 17th April

Maturiy date: 19th April

Tenor: 1 month (30days)

Yield rate: 8% per annum

Scenario 1: Prevailing spot rate does not go beyond (>) conversion rate

On fixing date, if MYR/GBP is trading at 4.86, which is above the conversion rate (4.810), you will receive MYR 5032.88. (Investment amount + Yield amount in base currency(MYR) on maturity date.

Scenario 2: Prevailing spot rate goes beyond (<) conversion rate

On fixing date, if MYR/GBP depreciates to 4.71, which is below conversion rate (4.810), you will receive

GBP 1046.34. As mentioned earlier, if the alternative currency depreciates below the conversion rate, you are commited to purchase the alternative currency at conversion rate.

Dual currency investment are structured by the banker as to share the risk of alternative currency depreciates beyond a certain level, which is structured in the bank's favor. It is a complex and risky product, where is not advisable for averse investor to invest. The banker might tell you if the currency drops, you may keep the currency and wait it to recover. This, is a misleading advice. The loss you made has occurred. Again you are unsure whether the currency will recover, and even if it do, you are unclear how long does it take to recover, the loss occurred is definitely made. If you keep it longer, you might suffer the risk of a bigger loss, and your opportunity cost.

This is not a game for people who invest their hard earned money.