STRATEGIC INVESTMENTS

Dual Currency
Deposits
Do You Know You
Have Become
The Insurer?
By Eng Tiang Chuan

Avoided like the plague during the financial crisis, structured products
are reviving like green shoots after a long awaited rain. Dual Currency
Deposits in particular, have been really popular. Depositors may not have
understood the risks involved.
Structured products earned a bad name after

version is diverted away to the possible uses

or Conversion Rate which is the pre-agreed

the Minibond saga in 2008. Many investors

of the new currency, for example, using it for

exchanged rate.

were badly burnt during the worst financial

a holiday, paying for childrens education or

crisis in living memory. Not all structured

for business. Not explained are the risks in-

products are bad. However, a big number

volved in this type of structured product.

of investors did not understand the risks in-

By entering into the Dual Currency

protect the position, a put-option is bought

volved and were shocked to see their invest-

Deposit, the depositor has actually sold a

and the option premium paid to the put-op-

ments turn into waste paper during the crisis.

Put-Option to the bank. There are different

tion seller. The put-option allows the option

While some structured products are

variations of the structure available. Before

buyer to sell the asset at a pre-determined

easily identifiable, others have been mis-

explaining how one type of DCD structure

price (strike price) if the asset price drops as

taken for having the low risk nature of plain

works, lets take a look at the terms used in

anticipated. The put-option seller, having

vanilla deposits. Dual Currency Deposits

the structured products:

collected the option premium, thus has the

obligation to buy the asset from the option

(DCD) are highly popular yet greatly misunderstood. Numerous investors were shocked

Put-Option A right, but not the obliga-

when told that their deposits had suffered

tion, to sell an underlying asset at a pre-

huge losses along with the many other in-

agreed price at a pre-determined date.

and the depositor is the option seller. The

vestments when they thought that deposits

Put-Option Seller The party that has sold

bank will typically sell the put-option bought

were supposed to be low risk. Many deposi-

the Put-Option. Has the obligation to buy

from the depositor in the secondary options

tors went ahead with the deposits without

the underlying asset at the pre-agreed

market or use it for internal hedging. If the

realizing they have actually entered into a

price and date.

option is sold in the secondary market, part

derivative contract.
A well-encountered sales pitch for DCD

40

Put-option buyers generally have a bearish view or wish to protect their holdings. To

Put-Option Buyer The party who has

bought the Put-Option.

buyer at the pre-determined price.

In a DCD, the bank is the option buyer

of the option premium collected from the

open market is passed to the put-option

would typically emphasize the higher inter-

Option Premium The price of the option.

seller in the form of the higher interest. The

est potential compared to a normal deposit.

Strike Price The pre-agreed price. In a

bank takes the rest of the premium as earn-

Attention on the scenario of currency con-

DCD, the strike price is called the Strike Rate

ings. If the option is used for internal hedg-

ISSUE 15 INVEST JUN/JUL 10

ing, the bank is able to buy the put-option

ance contract (put-option).

case scenario. However, if the insured event

cheaper than what is available in the market.

When the option structure is applied

occurs, ie, the exchange rate of the alternate

A simpler way of looking at the arrange-

to the DCD, the depositor becomes the in-

currency drops versus the base currency, the

ment is through an insurance perspective.

surance company who sells the insurance

depositor has to pay the life insured the base

The put-option seller is the insurer. The put-

policy to the bank who is the life insured.

currency (which is the stronger currency) and

option buyer is the insurance buyer look-

In exchange, the bank pays an insurance

take the alternate currency (which is now the

ing for insurance protection (to protect his

premium for the protection. The insured

weaker currency). The exchange rate is the

investment position). The insurance buyer

event is the drop in exchange rate versus

strike rate which is pre-determined. The fol-

(put-option buyer) pays an insurance pre-

the base currency. When nothing happens,

lowing figures illustrate how the DCD works.

mium (option premium) to the insurance

the depositor will pocket the insurance pre-

company (put-option seller) for the insur-

mium and pay out nothing. This is the best

At The Start of Dual Currency Deposit

Sell Put Option (Insurance) to Bank to

protect against drop in exchange rate of
AUD vs SGD. The exchange rate, called
the strike rate, is fixed in advance.

Depositor
(Insurer)
Holds the Base
Currency eg, SGD

Bank
(Life Insured)
Holds the Alternate
Currency eg, AUD

At Maturity of Dual Currency Deposit

Exchange Rate of AUD/SGD is Above Strike Rate
Ie, AUD strengthen against SGD

Bank Pays Premium for Put Option

(Insurance) in the form of higher interest

Depositor
(Insurer)
Holds the Base
Currency eg, SGD

Bank
(Life Insured)
Holds the Alternate
Currency eg, AUD

YOUR INVESTMENT INSPIR ATIONS

41

At Maturity of Dual Currency Deposit

Exchange Rate of AUD/SGD is Below Strike Rate
Ie, AUD weaken against SGD
The Bank takes delivery of the Base
Currency (SGD)
Bank Pays Premium for Put Option
(Insurance) in the form of higher interest

Depositor
(Insurer)
Holds the Base
Currency eg, SGD

Depositor takes delivery of the Alternate

Currency (AUD) at the pre-determined
exchange rate, in effect, taking less than
Bank
what the current exchange rate
(Life Insured)
would have provided
Holds the Alternate
Currency eg, AUD

As many DCD depositors found out, curren-

bers where risks are spread out. For the

the Minibond holders made. Do not assume

cies such as the Australian dollar dropped as

DCD Depositor, there is no risk pooling.

that there will be another round of compen-

much as 30% against the Singapore dollar

He bears all the risks. A single big currency

sations. Dont become an Insurer if you are

during the crisis. Many depositors were con-

movement against him could cause huge

not ready to be one.

verted to the weaker currency at easily 20%

damage.

to 30% higher exchange rate, thus suffering

An equity investor is compensated with the

big losses even after the higher interest rate.

upside by taking on the risk of downside

There are a few points that DCD deposi-

movement. In fact, theoretically, there is

tors have to take note:

unlimited upside (share price goes up and

Eng Tiang Chuan is a Chartered Financial

up) and limited downside (share price goes

Consultant with PromiseLand Independent.

The depositor always receives the weaker

to zero). In the case of a DCD, for a limited

He is licensed by the Monetary Authority of

currency (beyond the strike rate). Should

upside (higher interest), the depositor takes

Singapore to provide financial advice.

the Alternate Currency (eg, AUD) appreci-

on a much higher downside risks (huge

ate against the Base Currency (eg, SGD), the

currency movement). The depositor effec-

Email: tiangchuan@promiseland.com.sg

depositor still holds on to weaker currency

tively becomes the Insurer for the currency

Tel: 6505 4100

fluctuations.

Website: http://www.ifa-sg.com

(SGD). In the event the Alternate Currency

depreciates against the Base Currency

When promoting the DCD, the relation-

beyond the strike rate, the depositor is left

ship manager would typically emphasize

Although every reasonable care has been

with the weaker Alternate Currency (eg,

the uses for the currency should there be

taken to ensure the accuracy of the infor-

AUD).

a conversion. Is there really a need for the

mation contained in this article, the author

currency or is the need just a marketing

cannot be held liable for any errors, inaccu-

gimmick?

racies, and / or omissions however caused.

The exchange rate used for converting to

the Alternate Currency is not the spot (current) exchange rate. The conversion takes

Deposits are low risk savings. If the deposi-

This article represents the personal views of

place at a disadvantageous rate which

tor needs or wants a low risk product, a DCD

the author and is for information only and

was decided in advance. Depositors could

is definitely not for them.

does not constitute an offer or solicitation

suffer huge loses being forced to convert at

42

Written By: Eng Tiang Chuan

of any purchase. Any advice herein is made

the higher rate strike rate. In order words,

Despite the lessons from the Lehman Mini-

on a general basis and does not take into ac-

the depositor can convert currencies at the

bond fiasco, Dual Currency Deposits are still

count the specific insurance and investment

current exchange rate which is much lower.

aggressively peddled to depositors. Carry-

objective of any specific persons or groups of

With a DCD, the depositor effectively be-

ing an inappropriate name with the word

persons. The reader may wish to seek advice

comes an Insurer. Insurance works on the

Deposit, non-discerning depositors could

from a financial adviser before purchasing.

basis of risk pooling and law of large num-

again be making the same mistakes that

ISSUE 15 INVEST JUN/JUL 10