FOREIGN CURRENCY ACCOUNT

Meaning of Foreign Currency Account

Dictionary

With a foreign currency account, consumers can trade in foreign currencies. However, the future development of exchange rates can hardly be foreseen. Speculations on exchange rate gains are therefore risky. Some investors also use foreign currency accounts to reduce the exchange rate risk for investments that are settled in foreign currency.

  • A foreign currency account is not managed in euros, but in US dollars, Swiss francs or Japanese yen, for example.
  • Investors can thus speculate on exchange rate gains.
  • With foreign currency accounts, financial investments in other currencies are also hedged against exchange rate fluctuations.
  • The statutory deposit guarantee does not always apply to credit balances on the foreign currency account.

What is a foreign currency account?

Many corporate customers use foreign currency accounts for their international payment transactions. But numerous German banks and online brokers also offer foreign currency accounts for private customers. The total offer on the market is diverse: While some banks only offer a dollar account, investors with other providers can also invest in other currencies – for example in Swiss francs (CHF), Norwegian kroner (NOK), Japanese yen (JPY) or British Pound (GBP).

A foreign currency account is usually managed in a similar way to a call money account . The money is then simply available daily in a foreign currency in the account. In particular, many online brokers offer the foreign currency account also used to process securities purchases abroad. Often the account is then permanently linked to the depot. The deposit is then the prerequisite for customers to be able to open a foreign currency account with the same provider.

The foreign currency account as a speculative instrument

Many investors use their foreign currency accounts to speculate on exchange rate gains. For example, you buy US dollars at a certain rate and then exchange the money back into euros at a later point in time. If the dollar has risen against the euro in the meantime, you will get more money back than you originally invested. In the event of an unfavorable price development, however, there is a risk of losses.

Speculating in currencies is risky

Anyone who exchanged euros for dollars at the official exchange rate at the beginning of 2017 received a total of 10,520 US dollars for an investment of 10,000 euros. Three years later – at the beginning of 2020 – the euro had risen. For their 10,520 dollars, investors would only have got back 9,399 euros at this point in time. Investors who exchanged euros for dollars at the beginning of 2018 and exchanged the money back after just one year did better. They exchanged their 10,000 euros at the exchange rate of 1.20 US dollars per euro (USD / EUR) and received 10,560 euros back after 12 months when they were exchanged for euros (exchange rate: 1.14 USD / EUR). That corresponds to a return of 5.6 percent.

The future development of currencies is extremely difficult to predict, even for professionals. Speculating on exchange rate gains is therefore an extremely risky investment. The more volatile a currency is, the more so. The Turkish lira (TRY), for example, has lost almost half of its value compared to the euro in three years.

Exchange rate fluctuations: how much is 1 euro worth?

currency Jan. 2020 Jan. 2019
U.S. dollar 1.12 USD 1.15 USD
British pound £ 0.85 £ 0.90
Swiss franc 1.09 CHF 1.13 CHF
Japanese yen 121.62 JPY 125.69 JPY
South African rand ZAR 15.72 16.47 ZAR
Turkish lira 6.66 TRY 6.06 TRY

Invest overnight money and fixed-term deposits in a foreign currency

With some banks, customers can use their foreign currency account as a reference account to invest overnight money or fixed-term deposits in foreign currencies. If the account is in the currency of a country with higher interest rates, the interest rates offered are often quite attractive. In January 2020, some banks paid around 2 percent interest for one-year fixed – term deposits in US dollars. At the same time, savers for fixed-term deposits in euros received a peak of 1.12 percent.

Nevertheless, investing overnight money and fixed-term deposits in foreign currency remains risky. Because the losses due to an unfavorable development of the exchange rate can turn out to be higher than the profit due to the higher interest rate compared to investing in euros. For this reason, overnight money and fixed deposits in foreign currencies are by no means to be equated with the very secure overnight and fixed deposit account that is kept in euros.

Interest has tax implications

In any case, interest on the foreign currency account is a double-edged sword: Usually, no taxes are levied on profits from foreign exchange trading if there is at least a year between the purchase and sale of the foreign currency. However, this holding period is extended to 10 years if investors generate interest income with their foreign currency account.

Reduce the exchange rate risk with foreign currency accounts

Short for FCA by abbreviationfinder, foreign currency accounts aren’t just used for speculating. Some investors use them as an instrument to reduce their exchange rate risk and keep part of their assets in foreign currency. US stocks, commodities, gold and numerous other financial investments are commonly traded in dollars around the world. Consumers without a foreign currency account can also participate in trading. When buying shares, for example, the bank in Germany would then first convert the investment amount from euros to dollars in the background and then buy the shares from the dollar amount. After the shares were sold, the proceeds would then be converted back from dollars to euros.

Investors must therefore take into account another variable when making their investment decisions: not only the further course of the price of the purchased shares, but also the exchange rate from dollar to euro determines the success or failure of their investment. If the purchase and sale is processed directly in dollars via a foreign currency account, exchange rate fluctuations no longer have any direct influence on the effective return on the current investment. An exchange rate risk only arises if the dollar assets are to be converted back into euros at some point.

Foreign currency account comparison: Pay attention to the conditions

Consumers can find foreign currency accounts at numerous banks and brokers on very different terms. The most important criterion is of course that the desired currencies can be traded at all. In addition, interest rates play a role. If you do not want to tax profits from foreign exchange trading, it is best to choose a foreign currency account without interest – then exchange rate gains are tax-free after a 12-month holding period. If you choose a foreign currency account with interest, you should pay attention to the level of the interest rate.

Foreign currency account fees

In addition, consumers should keep an eye on costs when choosing their foreign currency account. While many established banks in particular charge monthly fees for account management , the foreign currency account with other banks and brokers is free – in some cases, however, only in connection with a custody account, which can sometimes incur costs.

The second possible cost factor is the conversion fee when exchanging currencies. Many providers require a certain proportion of the investment amount or a flat-rate minimum fee. With some foreign currency accounts, the exchange is also free of charge. As with any financial investment, the following applies in principle: All costs are at the expense of the return. Investors are therefore well advised to take the running costs into account when selecting their foreign currency account.

Deposit protection with the foreign currency account

The security of the deposits can also play an important role in the selection of the foreign currency account. The statutory deposit insurance only includes deposits that are denominated in euros or another EU currency. The statutory deposit protection for such funds is 100,000 euros across the EU. In the event of compensation, the sum will be paid out in euros. The exchange rate is the reference rate of the European Central Bank on the day on which the compensation event is determined.

However, the statutory deposit insurance does not apply to the part of the savings that is held in the currency of a non-EU country – for example in US dollars or Swiss francs. However, numerous banks voluntarily offer their investors a higher level of protection. If the provider of the foreign currency account is a member of a voluntary deposit protection fund, deposits in foreign currency are also covered. In the case of private banks, this is done by the deposit protection fund of the Association of German Banks (BdB). In the case of savings banks and the Volks- und Raiffeisenbanken, the respective institute security applies.

FOREIGN CURRENCY ACCOUNT