- A foreign currency CD allows an accountholder to invest in a time deposit denominated in a currency other than the U.S. dollar.
- Investment is possible via a U.S.-based financial institution that offers foreign currency CDs or a foreign bank that establishes accounts with foreign investors.
- Foreign currency CDs can offer relatively high interest rates, but they expose investors to exchange rate risk, which can easily overshadow the potential for incremental yield.
What Is a Foreign Currency CD?
A foreign currency certificate of deposit is a type of CD in which the account is denominated in a variety of other currencies, such as Canadian dollar, the Eurozone euro, the Mexican peso and the South African rand.
It is offered by many financial institutions to their customers and provides the accountholder a guaranteed rate of interest in exchange for a commitment to leave their savings in the account for a specified amount of time. Generally, early withdrawal results in a loss-of-interest penalty.
A key differentiating feature between a traditional CD and a foreign currency CD is the rate of interest achievable through a foreign currency CD. Some currencies, particularly those representing emerging markets, offer markedly higher rates of interest than traditional CDs.
How Does a Foreign Currency CD Work?
Investment in a foreign currency CD is possible through a U.S.-based financial institution that offers such instruments or a foreign bank that offers savings accounts to foreign investors. These days, an online application is the most efficient approach for either option.
Just like a traditional CD account, a foreign currency CD account entails an upfront deposit that must remain invested for a specified amount of time. Typically, it must stay invested for anywhere between one month to five years, and early withdrawal results in a loss-of-interest penalty.
Assuming no early withdrawal violations, the balance deposited in the CD will earn interest at the specified annual percentage yield (APY). In some cases, interest payments will be regularly distributed. In other cases, all interest will be paid at maturity.
The process for investing in a foreign currency CD is as follows:
- You complete an application and provide the required personal information.
- You give the financial institution the amount of money you want to invest. Ideally, you can do so using U.S. dollars, and the CD issuer will immediately convert your funds to the pertinent foreign currency — likely, for a fee.
- Your new account will begin accruing interest per the terms of the CD agreement.
- At maturity, your principal balance and accrued interest will be exchanged from the foreign currency back to U.S. dollars — again, likely for a fee — and disbursed to you. If you purchase a CD that makes intermittent interest payments, these cash flows will be handled in the same manner.
Foreign currency CDs are typically not recommended for the average investor. They entail high risk, which rails against the stable-value, guaranteed nature of a traditional CD.
Are Foreign Currency CDs Risky?
Foreign currency CDs are exposed to exchange rate risk. This is exposure to the possibility of losing money when converting an asset denominated in a foreign currency to U.S. dollars. For well-established currencies, the risk can be minimal.
When exposed to exchange rate risk, you will gain money when the U.S. dollar depreciates relative to your investment’s foreign currency. Conversely, you will lose money when the U.S. dollar appreciates relative to your investment’s foreign currency.
For less established currencies, including those representing volatile emerging markets, the risk is considerable. For these currencies, foreign exchange losses can easily wipe out any interest earned on a foreign currency CD. They can also result in a loss of principal.
When investing in a foreign currency CD, doing so via a domestic financial institution is optimal. They will offer you either FDIC or NCUA insurance protection. However, if you buy a CD from an overseas institution, you will forgo that protection.
It’s important to note that there is also some degree of risk with traditional CDs. For example, they are exposed to inflation and a high degree of illiquidity — meaning, you cannot access your money for a specified period without incurring a penalty.
Alternative Method for Investing in Foreign Currencies
If your primary reason to invest in a foreign currency CD is to gain exposure to a foreign currency, there are other ways to do so. The most straightforward approach is to buy an exchange-traded fund (ETFs) designed to track a foreign currency or basket of currencies.
With nearly 20 ETFs traded on the U.S. markets, currency ETFs have total assets under management (AUM) of over $3 billion, with an average expense ratio of 0.62%.
The Largest Foreign Currency ETFs in December 2022
- Invesco’s CurrencyShares Euro Trust ($284 million AUM)
- Invesco’s CurrencyShares Swiss Franc Trust ($212 million AUM)
- Invesco’s CurrencyShares Japanese Yen Trust ($187 million AUM)
These three funds are long the currency they represent, meaning they perform well when the currency of focus appreciates relative to the U.S. dollar, and they perform poorly when it depreciates relative to the U.S. dollar.
There are also inverse funds that allow you to bet against the direction of a given currency. For experienced investors, there are also leveraged funds that allow you to borrow funds and amplify your returns (or losses).