Definitions

Dual currency deposit

In finance, a dual currency deposit is a derivative instrument which combines a money market deposit with a currency option to provide a higher yield than that available for a standard deposit. There is a higher risk than with the latter - you can receive less funds than originally deposited and in a different currency. So one could do a USD/JPY DCD depositing USD and receive JPY.

Formal Definition

A fixed deposit with variable terms for the currency of payment. Deposits are made in one currency, but withdrawals at maturity occur either in the currency of the initial deposit or in another agreed upon currency. This is a deposit that creates a foreign exchange rate risk for the investor. Similar to a currency swap, you can be rewarded or punished for the risk taken.

Underlying a DCD, the customer sells an FX option to the bank, which gives the bank the right to exercise the option (in which case the customer receives its deposit back in a different currency). The bank pays the customer the option premium in the form of an increased interest rate on the deposit. The customer is thereby unaware of the underlying FX option.

Example

Customer is Bill Gates.

• He has homes in UK and US and so has savings in GBP and USD.
• He wants to earn more than the 4.37% deposit rate for 1 month for \$100,000 savings
• He has a view that GBP/USD spot is going to go slightly down below its current 1.9672

So he enters into a \$100,000 1-month GBP/USD DCD with a conversion rate of 1.96.

Motives

Customer

The customer wants to receive a higher return than the deposit rate for their investment currency in return for the risk of receiving the returns in a different currency.

Bank

The FX Options Desk of the bank is best able to price and manage the risk for these sorts of products, and also benefits from the extra liquidity (more options!) in their book, making it easier for them to cancel out the risk of different buy/sell positions.

The Sales person is eager to provide the customer with all the investment opportunities possible and generally earns higher fees on more complicated / new products.

Financial Maths

DCD+

The DCD is actually composed of a normal deposit and an option.

Normally in the options market the seller of an option is paid before the premium value date or "spot date" (for more information see FX Date Conventions) however in the case of the DCD the client is paid at the end of the deposit period. For this reason some banks offer their clients a product commonly called DCD+ which includes an interest element to account for this.

Adding this to the deposit redemption-amount means that the amount of currency that will need converting if the option strike is passed at expiry has now increased. So the option face amount needs to be altered to take the extra interest into account. This affects the premium again, and so on.

To avoid having to compute this to infinity one can use a Geometric series with

$a = 1+rfrac\left\{delivery term days\right\}\left\{currency basis\right\}$

and

$r = yield of option$

where yield is the forward value (or FV) of the option premium giving a multiplier to change a DCD's option premium to a DCD+ of:

$multiplier = frac\left\{1+rfrac\left\{delivery term days\right\}\left\{currency basis\right\}\right\}\left\{1-y\right\}$

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