What Are Bank CDs?
A Certificate of Deposit (CD) is a stable investment that must mature, but offers higher interest rates than a bank savings account.
A bank CD (certificate of deposit) is a stable debt instrument issued by a bank that often pays interest, usually bringing a higher interest yield and more options than a standard savings account. Bank certificates of deposit are an integral part of the structure of any depository institution that offers them. Bank CDs present important benefits to the bank or thrift that issues them and to the consumer as a safe and easy alternative to non-interest bearing institutions. CDs are eligible for retirement accounts and taxable accounts, and are subject to federal and state taxation.
The Use of CDs in the Banking Structure
Certificates of deposit resemble bonds in many ways. Almost all issuance is non-callable before maturity, there is a specified interest rate, the credit rating is that of the United States guarantee, and there is a stated maturity. Certificates of deposit are created when an investor chooses among maturities ranging from a few months to several years. Bank rates are competitively set, rates are regulated under Regulation T by the Federal Reserve Bank, and all bank advertising must be pre-approved by banking regulators.
CDs as a Lending Resource
Certificates of deposit are stable. Most bank clients roll over or renew their CDs when they come due. Compared to checking accounts and savings accounts, CDs are a dependable source of funds for banks to then use for lending purposes. As a result, the reserve requirement or the amount of deposits that must be kept aside is very low and allows banks to lend with a low cost of funds.
Safety of Principal and Interest Considerations When Purchasing CD's
Consumers have many choices when deciding to buy a CD. Although rates are competitively set, it's now possible to see rates--through an online broker--of CDs from across the country. Because certificates of deposit are guaranteed by the United States up to $100,000 (with temporary limits up to $250,000) for principal and interest, customers can choose the highest-yielding certificate available in their time horizon. CDs are typically offered with maturities ranging from a few months to several years.
Marketing Considerations When Purchasing CD's
Consumer preferences have increased the variety and type of certificates of deposits available. For customers willing to take on maturity risk, some banks and thrifts offer callable certificates of deposit that have higher initial yields. Customers can buy short-term certificates that can be rolled over before maturity into higher-yielding, longer term CDs. Currency risk can be hedged with CDs denominated in other currencies or a basket of currencies. Given the importance of certificates of deposit to a bank's lending structure, the trend to greater accommodation to CD purchasers is likely to continue.
APR is the Key Metric to Buying CDs
Depending on the maturity and type of CD, interest may be offered at maturity or payable monthly or quarterly. In order to find a common comparison of rates, consumers should concentrate on the annual percentage rate or APR. The APR compounds the different payment terms as if all payments were smoothed over the course of a year. APR is the only common thread for comparing CDs with different maturities or terms of payment.