Certificates of Deposit

Orlando, Florida Investment Attorney, Russell L. Forkey, Esq.

All investors have heard of certificates of deposit.  Notwithstanding, the foregoing, this post is designed to alert the unsophisticated and remind the experienced certificate of deposit investor to read the fine print.  The purpose of this post is to provide the reader with general educational information about various types of certificates of deposit that have evolved over the years. Please keep in mind that any information contained herein should not be considered as legal or investment advice. You should consult experienced professional, if you have any questions concerning anything that you read on this page.

General Information and FAQs Concerning Certificates of Deposit - Protect Your Money by Checking the Fine Print

There are a number of types of certificates of deposit that investors should be aware of. Fundamentally, the principal of certificate of deposits is usually insured by the Federal Deposit Insurance Corporation, currently up to $250,000. It is the remaining features of a certificate of deposit that can vary. That is why we encourage you to fully read and understand what you are investing in. It is always a lot easier to deal with any problems that you perceive in advance than after you have made the investment.

What is a Conventional Certificate of Deposit?

Even if you are not an "investor" in the conventional sense, almost everyone dealing with a commercial bank as heard of the phrase "certificate of deposit." But, what is a certificate of deposit? It's simple really. A certificate of deposit is nothing more than a promissory note by which the bank borrows money from the customer (the "investor") for a set period of time, at a fixed interest rate. Usually, the longer the maturity the higher the interest rate paid. A certificate of deposit is a very safe investment, as long as the amount of the money loaned, to the bank, by the customer does not exceed $250,000 as this sum is insured by the Federal Deposit Insurance Corporation, if the bank is a member.

As with any promissory note, the terms of the instrument control. Therefore, it is important for the investor to carefully review, the terms of the certificate of deposit. Not only does the document contain the information referenced in the preceding paragraph but, it contains other important information relating to the terms of the transaction. For example, most certificates of deposit contain an early withdrawal fee, which is nothing more than a penalty used to act to act as a deterrent to the customer for doing so. Consequently, most investors would not want to make an early withdrawal unless they had an urgent need for the money.

What is a Callable Certificate of Deposit?

A callable certificate of deposit is exactly what the phrase implies. A bank will issue a certificate of deposit that allows the bank to redeem (call away) the certificate of deposit, from the investor, prior to maturity of the investment usually within a given time frame, and at a present call price. The call price is usually at a premium to the investor's purchase price and is used as an incentive for the investor to take the call risk. A bank will usually exercise this right of redemption if interest rates decline below the interest rate that the bank is paying on the certificate of deposit.

What is a Variable Rate Certificate of Deposit?

As the phrase implies, a variable rate certificate of deposit has all of the characteristics of a certificate of deposit except it pays a variable as opposed to a fixed rate of interest. The interest rate rises and falls based on the movement of the underlying index, which can be based on such things as the such as the prime rate, consumer price index, treasury bills or a market index. The amount paid out is usually based on a percentage difference between the beginning index and the final index.

What is an Uninsured Certificate of Deposit?

An uninsured certificate of deposit is rare. It functions in the same manner as an insured certificate of deposit, except that it usually pays a higher interest rate because in the event that the financial institution that issued the uninsured certificate of deposit goes out of business, the investor bears the entire burden of loss.

What is a Zero Coupon Certificate of Deposit?

A zero coupon certificate of deposit is purchased at a largely discounted rate face amount. It differs from a traditional certificate of deposit in that interest payments are not received yearly, but rather as a lump sum at the date of maturity. The advantage of a zero-coupon certificate of deposit is that there is no interest reinvestment risk, unlike certain CD's that pay interest at regular intervals. The disadvantage to investors is that even though interest is not paid annually, it is deemed to have accrued annually and is treated as the investor's taxable income, which means that tax is payable every year on the accrued interest for the term of the CD. Consequently, the investor must have enough money to pay the tax bill each year during the life of the investment.

What is a Negotiable Certificate of Deposit?

It generally is a certificate of deposit with a minimum face value of $100,000. These are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed-in before maturity. Due to the minimum face value of these certificates of deposit, they are purchased frequently by large institutional investors.

What is an Index-Linked or Equity-Linked Certificate of Deposit?

The same general terms associated with most all certificates of deposit apply, except that the return, to the investor on this type of CD, is based upon the return of a specific index. These CDs are purchased for a fixed price. There is a chance for a high return, depending on the outcome of the index, and there is no risk of a loss as the CD is FDIC insured. While these CDs offer a potentially higher return than many other variations, they are not the safest investment. Even though the initial investment will never be lost, there may be no return on the index.

What is a Liquid Certificate of Deposit?

This is a type of certificate of deposit that allows withdrawals to be made, without penalty, from the account. The major upside to this type of CD is that your money is accessible to you if you need it throughout the term. The downside is that the interest rate is generally lower than that of a traditional CD.

Please make sure to read the terms under which withdrawals can be made. Some banks require advance notice and/or that a minimum balance is kept in the account. Additionally, there may be some restrictions on the amount or frequency of withdrawals.

What is an Add-On Certificate of Deposit?

A certificate of deposit that allows the bearer to deposit additional funds into their CD, after the initial purchase date that will bear the same rate of interest. Obviously, add-on certificates of deposit are beneficial if investors believe that interest rates are going to decline.

What are some of the difference between Brokered CDs Vs. Bank CDs?

As an investor, you know that you can purchase a certificate of deposit from a bank, but did you know that you can also purchase CDs through a brokerage firm? Brokered CDs usually pay a higher interest rate because of the volume of CDs that banks buy from banks for resale.

Brokered CDs usually have a longer term than bank CDs, which means you, must wait longer to get your principal back. Bank CDs usually last between one and five years while brokered CDs commonly last 15 years or more. According to USA Today, some brokered CDs are also callable, which means that the bank can decide to end the CD early if it no longer likes the terms without penalty. However, you cannot choose to end a callable CD without penalty if you no longer like the terms.

Probably the biggest difference between and bank CD and a brokered CD is that the brokered CD can be resold through your broker on the secondary market. This means that you can avoid paying the early withdrawal penalty, on the one hand. However, on the other hand, if the market has moved adversely to your position, the value of your CD could have dropped to a point lower than the penalty that you would have paid with a bank purchased CD.

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