THERE is a growing demand for foreign currencies in Malaysia. As people become more affluent, they travel abroad more, send their children overseas for education and invest in foreign assets, such as properties or equities. 

According to data on Bank Negara Malaysia’s website, individual holdings of foreign currency deposits in the banking system have increased almost six-fold in the last seven years, from RM2.46 billion at end-2007 to RM12.68 billion at end-2014.

This growth comes in tandem with Bank Negara’s liberalisation of foreign exchange (FX) policies, which have allowed local investors to participate in the FX market, according to Alliance Bank Bhd head of group financial markets Tan Eng Kiang.

“In the foreign exchange market space, prior to the central bank’s liberalisation measures, people had limited choice in terms of their [foreign currency] investments,” he says. “But when the central bank became a little more liberal in allowing investors to put their money in the FX market, dual-currency investments (DCIs) mushroomed.”

DCIs have been gaining traction for some time. According to Danny Chang, Standard Chartered Bank Malaysia Bhd’s head of managed investments and products management, such investments were first offered in 2007 by foreign banks to meet the rising demand for foreign currency in the country. Local banks only caught up a few years later. 

But today, investors can find these products at nearly every major Malaysian-based bank. J A Leong, wealth management product head at Citibank Bhd, says the market has responded to DCIs because Malaysian investors are now more savvy. 

“There has been a growing appetite for these products in Malaysia for the last 10 years. Today, DCIs are increasingly a part of an investor’s portfolio,” he says. 

“Investors are savvier, more market-sensitive and understand the importance of currency diversification for their individual investment portfolios.”

However, with central banks around the world using their monetary policies to stimulate growth, volatility will continue to be a feature in FX markets. And as volatility increases, investors will need to be agile to navigate the ups and downs. 

What are DCIs?

DCIs are structured investments aimed at people who have a need for foreign currency. Instead of converting their cash at a money changer, investors go to a bank and enter into a DCI contract.

When entering into a DCI contract, investors pick a pair of currencies — a base currency (usually the ringgit) and an alternate currency. Then, they determine a strike rate, or a rate at which they would be happy to see the base currency converted into the alternate currency. They also set a tenure for the investment to mature or expire.

If the base currency has weakened more than the alternate currency at the end of the tenure, the investor will receive his original investment back in the base currency, plus a yield on the investment from the bank. However, if the alternate currency has weakened until it touches or moves beyond the strike rate, the investor will receive his original investment plus the yield in the alternate currency at the pre-determined strike rate.

A risk investors must be aware of is that if they convert their investment back into the base currency at the prevailing spot rate, they might receive less of the base currency if the base currency weakens. 

However, this will not be a problem if investors have a need for the alternate currency in the first place. RHB Banking Group’s group treasurer Mohd Rashid Mohamad says investors looking to get into DCIs must always begin with a need for the alternate currency, just in case it gets converted.

“Which alternate currency investors choose depends on their requirements. Most of the requirements that we have seen are for education purposes. When it comes to DCIs, it should always start with the investor’s requirements,” he adds.

Investors should also begin with a view of where the currency is headed, says Alliance Bank’s Tan. “Investors who have a view that a certain foreign currency will appreciate will not mind getting converted as they will hold on to it, while enjoying the higher yield the bank is offering. So, the currency must be one investors are willing to hold on to.”

DCIs are attractive for several reasons. One is that a higher yield is possible because effectively, investors have sold a put option to the bank where it has the right to deliver the weaker of the two currencies at the end of the contract’s tenure. 

The higher yield comes from a premium that is embedded into the option’s pricing. What determines the yield is the volatility of the currencies, as a result of the pre-determined tenure, strike rate and the choice of the currencies.

“The higher the probability of hitting the strike rate [getting the investment converted into the alternate currency], the higher the yield will be,” says Standard Chartered’s Chang. “Investors are selling an option in return for a premium, which is the higher yield.”

Another plus is that DCIs are highly customisable to the needs of the investor, he adds. “Investors can choose the alternate currency and the tenure. Also, the product is now fairly homogenous across [the banks], so investors can almost compare them.”

Typically, the tenure for DCIs is a week, two weeks or a month, says Chang. “Some investors ask us if we can do a DCI for three or five days, and the answer is we can. The tenures depend on the bank as some banks may want to keep it standardised at a week or a month.”

DCIs allow investors to take a view of the FX market without having to physically hold cash, says Tan. “When you want to participate in foreign currency investments, you can actually do so by going to the money changer. But you cannot deposit the cash in a bank because banks do not receive [foreign currency] notes over the counter. That is the one drawback — you cannot earn interest [on the currency] even though you have a view of the currency appreciation.”

Investors should be mindful that even though they are opening a foreign currency account with a bank when participating in a DCI, it is not a fixed deposit and the money deposited into the foreign currency account is not eligible for protection under Perbadanan Insurans Deposit Malaysia. The DCI is a structured investment and it falls under the structured product category of banks.

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on April 27 - May 3, 2015.

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.