certificate of deposit

Investment Dictionary -> certificate of deposit

The certificates of deposit (CD) are promissory notes offered by commercial banks, thrift institutions, and credit unions. Sometimes, they can be purchased from brokerages. The brokerage companies may negotiate higher interest by promising to the issuing institution an increased number of holders.

This type certificate represents time or fixed deposit that cannot be withdrawn without penalty. The penalty for a five year certificate may amount to six months of interest. This said, certificates have to be held for the specified period of time. At the end of the term, the holder may decide to keep the deposit for another term or withdraw the funds. As a rule, the holder is entitled to receive interest which is determined by the length of the period during which the deposit is kept. Longer terms result in better yield on the deposit. Other factors that determine the interest are the current interest rate, the invested amount of money, and the particular institution of choice. In has to be noted that the time deposits pay higher interest rate than demand deposits such as checking accounts. The reason is that the holders cannot withdraw the time deposits at their convenience. Moreover, the time deposits are slightly riskier for the issuing institutions. Some banks will require sixty or ninety days notice before they issue payment.

The main advantage is the relative safety of the certificates of deposit. In addition, the holders know their return in advance. The certificates of deposit usually require that the holder makes a minimum deposit. Two types of certificates can be differentiated: small denomination and large denomination time deposits. The small time deposits are made for sums under $100.000. The amount of this investment is guaranteed by the Federal Deposit Insurance Corporation coverage. This is the ceiling on the coverage, as set by the FDIC. The large denomination deposits represent deposits for sums above $ 100.000.

The Australian and New Zealand bank institutions have similar regulations on time deposits. The holder signs an agreement which stipulates that the funds shall be kept for a specified term. Alternatively, the bank may require a prior notification or impose penalty on early withdrawals.

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