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What is a Foreign Currency Investment?

By Justin Riche
Updated May 17, 2024
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A foreign currency investment is primarily undertaken to profit from the fluctuations in the foreign exchange market. This investment can be accomplished through various ways and for individual reasons. A foreign currency investment can take many forms. Two examples of these are a purchase of a certificate of deposit (CD) denominated in foreign currency from a local bank and foreign currency trading activities. Moreover, multinational corporations and other institutional organizations have their own foreign currency investment schedules and for different aims.

A foreign currency CD, for example, typically yields higher interest than normal savings accounts. This CD can be held for different periods, generally six months to five years, or more in particular instances. A foreign currency CD can be obtained from a local bank, is normally insured and, in some cases, is tax-exempt. As a result, many people will find the CD to be a very alluring foreign currency investment.

Moreover, an individual might want to hold a foreign currency account in a bank as a protection from an eroding local currency. For example, a United States citizen might believe that the economic environment at a given time might lead to a perpetually declining US Dollar. This might continually curtail his or her spending power, and for that reason, holding an account in Swiss Francs, say, might offset this risk.

Buying foreign currency can be an ideal investment for those who are planning to travel abroad. This is done if one believes that his or her national currency will decline remarkably before they travel overseas. The purpose for the investment, therefore, is to lock in a favorable exchange rate way ahead of the planned trip.

Furthermore, an individual might consider a foreign currency investment through various avenues, such options trading or futures trading. These investment vehicles are essentially derivatives, meaning that the underlying values of specific currencies are traded for profit without requiring the person to own or acquire the physical currencies. There are plenty of retail brokers who offer these services to individual investors.

Investing, naturally, comes with risks, and this is no different to a foreign currency investment. Accordingly, an individual might want to seek professional advice before involving himself or herself in this particular avenue. Alternatively, some people choose to park their money with a professional fund manager who makes foreign currency investment decisions for them.

Companies make use of the investment services available to individuals and many more. In the case of a multinational corporation, it will make use of foreign currency investments, especially to hedge against adverse changes in particular international currencies. For example, a U.S. company might enter into a forward contract with a bank, with the stipulation to sell to it a specific amount of foreign currency in exchange for US Dollars at an agreed date in the future.

Forward contracts are chiefly used by large companies involved in international trade. With the volatility in the currency market, exchange rates can rise or fall violently and might corrode their profits and/or cause major losses. A forward contract, therefore, is somewhat like investing in an insurance policy against unfavorable fluctuations. Moreover, both parties in the contract are legally bound and will fulfill their obligations, irrespective of the specific foreign currency's subsequent appreciation or decline, after their agreement.

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