12% interest from Icelandic CDs: what's the catch?

Factual Questions
1

I just heard of a US brokerage house that will sell you foreign CDs. Many of them pay 4, 5, or 6% interest. However, Icelandic CDs pay 12% interest.

The way it works: The day you “buy” a foreign CD, your dollars are converted to the foreign currency, then a CD is purchased for that foreign denomination. After the term of the CD is up, your principal plus interest is converted back to US dollars.

Several questions:

  1. Anyone have knowledge why Icelandic CDs pay so much more? Some of my ideas:
    a. Their inflation rate either is high or expected to be high.
    b. The value of the Icelandic Krona is expected to fall vs. the dollar

  2. Is the Icelandic economy stable or unstable?

  3. Are there any predictions for the Krona to fall in relation to the dollar?

Any other opinions people have about the advantages / disadvantages of this are also welcome.

Thanks,
J.

2

Just a guess, but most likely B. Currently, Iceland is EXPENSIVE. The exchange rate is crappy for Americans. The house is probably trying to make up some of it’s cost back in the intrest.

3

Iceland is a favorite with the carry-trade crowd. The idea is to borrow currency of a country with low interst rates (like Japan), convert it into the currency of a country with high interest rates (like Iceland) and put it in a CD. The hope is that you’ll end up with enough kronur to make the reverse conversion and pay back the loan with something left over for profit. High demand from foreigners for Icelandic kronur has driven up the value of the currency something like 12 or 14 percent against the dollar so far this year. If the currency should continue to strengthen, your investment would return even better than 12% in USD terms. But the danger is that the krona may be in a bubble that could burst if the yen-krona carry trade becomes less popular during the life of the CD. Earlier this year, it looked like that was going to happen when a rating agency reduced the rating on Icelandic bonds, but the krona bounced back.

4

I believe New Zealand was in a similar circumstance.
My research turned up an out-of-control inflation rate in NZ.

5

Some quick searching on Iceland and inflation leads me to believe that the powers that be in Iceland are jacking up interest rates in an attempt to deal with high inflation. Last year it looks like it was about 8% but currently seems down around 4%.

http://www.sedlabanki.is/?PageID=202

6

Just remember is that you have the risk of converting back into the dollar at expiration.

You might want to review what happend the last time such activities were really popular, eg 1997.

7

Ok, after looking closely at this, I’ve decided against it. Ever Bank, the bank that offers Icelandic CDs, charges 0.75% currency conversion fee going in and going out, so here’s how the numbers look:

10,000                          Original Investment

  •   75                          Currency conversion fee
    9,925 Amount invested
  • 301 Interest at 12.28% (rounded up from 300.52)
    10,226 Total at end of 90 days
  •    77                         Currency conversion fee (rounded up from 76.70)
    10,149 Net amount to you after 90 days

Your gain of $149 is about a 1.5% gain for 90 days, or roughly 6% for a year.

These figures don’t take currency risk into account, however. You can buy CDs in the US that pay about 5% per year, with no risk to your capital. Just a small change in the currency exchange rate could wipe out your profit and some of your capital.

The potential gain isn’t big enough to justify taking on the currency risk, in my mind.

J.