The Dual Currency Deposit (DCD) is a popular cash-management tool for companies that have multi currency cash flows. Let’s take a simple example of a UK-based company who are importing goods from the USA. They have an occasional need for Dollars, but they have spare cash balances in Sterling.
UK rates are low, and they are earning very little interest on their Sterling deposits. The DCD can offer a higher-than-market Sterling interest rate as long as the company accepts that their Sterling deposit may be repaid to them in US Dollars. They are effectively selling a Call option on their Sterling to the receiver of their deposit, and it is the premium generated from the sale of this option that provides the above-market deposit rate. The company must decide at which GBP/USD rate they are happy for the conversion to take place (the strike price of the option) and when this could happen (the maturity of the option)
For example, the current deposit rate for GBP for 3 months is only 0.50%. The current GBP/USD rate is 1.5200. A customer who places a DCD in Sterling with a maturity of 3 months and a “conversion” rate of 1.5500 will earn an annualised rate of approx 3.00% on their Sterling, which is significantly higher than 0.50%. After 3 months, if the GBP/USD rate is above 1.5500, the company will be repaid their deposit in Dollars.
FX Derivatives do not have to be complicated – they just need to be explained in plain and simple terms.