What it means
A fixed deposit is a bank account where you agree to leave your money for a set term, such as six months or two years, in return for a guaranteed interest rate. In an FCFD, the account is held in a foreign currency such as US dollars, euros or pounds.
At maturity, you receive the original amount plus interest in that currency. People use FCFDs for several reasons.
Importers and exporters hold foreign currency to pay overseas suppliers or to store receipts, families save for overseas education costs, and investors diversify away from their home currency. The deposit provides a safe, predictable interest return on money that would otherwise sit idle.
The interest rate depends on the currency and the bank, and may be higher or lower than home currency rates. Rates reflect conditions in the country that issues the currency, and so do not always favour the depositor.
Banks usually charge a penalty for withdrawing early, and some countries have rules on who may hold such deposits. The main risk is exchange rate movement.
If the foreign currency falls against your home currency, the value of your deposit and interest falls when converted back. Interest earned can be wiped out by a currency decline, while a rise in the foreign currency adds a bonus.
Tax and accounting apply too. Interest is usually taxable, and a business holding an FCFD must translate the balance into its reporting currency at each reporting date, recording exchange gains and losses in its profit or loss.
This can create swings in reported profit even though the deposit itself is stable. For businesses, the best use is matching.
If a company knows it must pay $200,000 to a supplier in six months, holding a dollar FCFD for that period locks in both the amount and the currency, removing exchange rate risk on that payment. Using the deposit as a pure speculation is a different matter and carries real risk.
In practice
Real-world examples.
Example
An importer expects to pay a supplier $300,000 in nine months. She places that amount in a dollar FCFD that matures a week before the payment date. The deposit earns interest and removes the risk of the dollar rising against her home currency.
Example
A family plans to send their daughter to university overseas in three years. They open an FCFD in the currency of that country to build up funds. Interest accumulates while they avoid worrying about exchange rate swings affecting tuition costs.
Example
A trading company receives export payments in euros. Instead of converting immediately at a poor rate, it places the money in a euro FCFD for three months. The treasurer converts when the rate is more favourable.
Formula
Calculation
Maturity value (simple interest) = deposit x (1 + interest rate x years)
Suppose an investor places 50,000 units of foreign currency in a one-year FCFD at 4%. Maturity value = 50,000 x (1 + 0.04 x 1) = 50,000 x 1.04 = 52,000 units. At the start the exchange rate is 2.00 home units per foreign unit, so the deposit is worth 100,000 home units. If the foreign currency falls 6% to 1.88, the maturity value in home terms = 52,000 x 1.88 = 97,760 home units, a loss of 2,240 or 2.24% despite the interest earned.Case study
Seen in the real world.
Lakeside Imports is an illustrative, fictional company that buys goods priced in dollars and sells in its local currency. Its finance manager noticed that the company often converted currency at the last minute, sometimes at unfavourable rates.
She proposed setting aside $500,000 each quarter in a dollar FCFD that would mature just before the large supplier payment dates. The deposit earned 3.5% annually, which on a three-month term brought in 500,000 x 0.035 x 0.25 = $4,375 of interest per quarter.
In this fictional story the company stopped worrying about the exchange rate on those payments, and the interest more than covered the bank's fees. The lesson is that an FCFD works best as a tool to match currency and timing of known obligations, not as a way to bet on exchange rates.
Watch out
Common mistakes.
- Assuming a higher foreign interest rate guarantees a better return, when currency losses can exceed the extra interest.
- Choosing a term that does not match the date when the money is needed, which can force an early withdrawal and penalty.
- Forgetting that businesses must revalue foreign currency balances at reporting dates, creating exchange gains and losses in the accounts.
Questions
People also ask.
What does FCFD stand for?
It stands for foreign currency fixed deposit.
Is the interest on an FCFD guaranteed?
The interest rate is fixed for the term, but the value in your home currency can still change with the exchange rate.
Can an FCFD be withdrawn early?
Usually yes, but banks often charge a penalty or reduce the interest, so check the terms before committing.
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