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Most Fools know all about gaining foreign-market exposure through equities that are either based outside the United States or have significant business operations abroad. But what about currencies? Does holding a high-interest currency make sense? What are the risks? Here's a rundown of some currency-investment options.
There are a number of reasons to hold currencies. Investors can make a carry trade by selling low-yielding currencies to buy higher-yielding ones. Purchasing or selling a currency can hedge a future expense or payment denominated in a foreign currency. Or an investor may just want to diversify his or her cash holdings.
Moves in the exchange rate can rapidly wipe out any benefit from a difference in interest rates. Over the past month, for example, the euro has traded between $1.39 and $1.31. A 6% swing over a single month is a lot of volatility by itself -- factor in 40:1 leverage available in foreign exchange accounts, and the wrong side of a position can get very expensive very quickly.
Three ways to hold currencies
1. Foreign-currency bank accounts
If a U.S. investor wanted a U.S.-dollar CD, he or she would walk into the bank and buy one. But getting a CD or account denominated in some other currency isn't quite that simple. A search of several U.S.-based bank websites didn't turn up much on foreign-currency deposit accounts, I found just two banks -- EverBank and Union Bank -- that offer non-U.S. dollar accounts for U.S. residents.
2. Foreign-exchange (FX) accounts
FX accounts appear to be intended primarily for trading, but they could be used like a savings account in nearly any currency. An investor could open a U.S. dollar account, sell the dollars to buy a different currency, and collect the rollover interest. If no leverage were used, that would effectively create a foreign-currency savings account.
The standard lot size is high for most individual investors -- 100,000 units of the base currency -- although an Internet search turned up dozens of brokerages offering micro-accounts with lot sizes of 1,000 units. Foreign-exchange accounts allow investors to goose returns -- and losses -- with leverage, controlling a large position with just a little cash. FXCM (Nasdaq: FXCM ) and Gain Captital's Forex.com offer micro-accounts with leverage of up to 50:1. If foreign-exchange trading increases in popularity, the brokerage firms' stock may be a better investment than currency trading.
3. Currency ETFs
Currency ETFs may be the simplest approach for an investor to get foreign currency exposure, but they're also one of the most expensive. A spot check of ETFs from a few different providers turned up annual expense rates of around 0.4%, and investors would also pay brokerage commissions to buy and sell the funds. WisdomTree offers funds tracking the New Zealand dollar, euro, Japanese yen, Chinese yuan, and others, by investing in U.S. money markets and entering into currency swaps with a trade designed to match money-market rates in the target currency.
Rydex CurrencyShares ETFs hold currencies on account, and its funds include the Australian Dollar Trust (NYSE: FXA ) , Canadian Dollar Trust (NYSE: FXC ) , Euro Trust (NYSE: FXE ) , Japanese Yen Trust (NYSE: FXY ) , and others, including vehicles for holding the yuan and the pound.
Most investors have little need for a foreign-currency account, but keeping tabs on currencies can help understand some stock moves. S&P 500 (NYSE: ^GSPC) companies pull about 30% of their revenue from outside the United States. For companies that are net exporters, the exchange rate means extra dollar income when the dollar is weak and a headwind if the dollar is soaring. Either way, keeping tabs on euros, yen, pounds, and dollars can make an investor more Foolish, even if he or she never makes a currency move.