While bank products are part of the world of finance, many aren’t considered securities and therefore aren’t tested on this exam. Some bank products do overlap with securities concepts, though. You only need the basics: what these products are and how they can be used as investments.
We’ll cover these three products in this section:
Demand deposits are funds held in bank accounts that allow withdrawals at any time. Checking and savings accounts are the most common examples.
Certificates of deposit (CDs) are very similar to bonds, but they’re issued by banks. CDs pay a fixed rate of return based on the principal deposited, which is similar to a bond’s par value. The bank accepts a deposit for a predetermined period, pays interest during that time, and then returns the principal at maturity.
Jumbo CDs, also known as negotiable CDs, are large CDs that trade in the secondary market. They have a minimum denomination of $100,000, and denominations of $1 million or more are common - so many retail investors can’t afford them.
Financial institutions often buy jumbo CDs to park large amounts of cash in a relatively safe vehicle, or they may repackage them into smaller products to sell to retail investors. Typical institutional buyers include pension plans, mutual funds, and large financial organizations.
Because the minimum investment is larger, banks tend to offer higher rates on jumbo CDs than on traditional CDs. Jumbo CDs are typically short-term, with many maturing within one year or less from issuance. Some mature in as little as one week.
Bank deposits are generally covered by federally mandated insurance. FDIC insurance covers the loss of funds due to bank failure. Without this insurance, customers could lose their money if their bank went bankrupt. FDIC insurance (which banks are required to pay for) covers customer deposits up to $250,000 per bank.
Investors can obtain brokered CDs from financial firms such as broker-dealers. These firms buy large quantities of individual CDs (sometimes jumbo CDs) and then re-sell them to customers. Because the broker-dealer buys in bulk from the bank, it may be able to offer higher yields than a customer could get by going directly to the bank.
Brokered CDs can have maturities across a wide range, from as short as a month up to 30 years. Like jumbo CDs, brokered CDs are negotiable and can be traded in the secondary market before maturity.
As long as the CD is titled in the customer’s name (which occurs upon purchase), the investor receives FDIC insurance of up to $250,000 per bank. One advantage of brokered CDs is that you can spread deposits across multiple banks - often through a single brokerage firm - to increase total FDIC coverage.
For example, if an investor wants $1 million of FDIC insurance, they could buy four $250,000 brokered CDs from four different banks through one brokerage firm. The deposits are fully insured as long as the investor doesn’t exceed $250,000 per bank.
Because CDs expose investors to relatively low risk, they generally offer relatively low yields (compared to other debt securities). They’re most suitable for investors who want a safe place to hold cash.
The US Dollar is considered the world’s reserve currency, and many goods and services are bought and sold worldwide in dollars. As a result, it’s common to find US Dollars held in banks outside the United States. When a US Dollar is held in an account outside the United States, it’s known as a Eurodollar deposit.
Don’t let the name mislead you: even if the US Dollar is held in a foreign country outside of Europe, it’s still considered a Eurodollar deposit. For example, US Dollars held in Ecuador, Nigeria, or South Korea are Eurodollar deposits.
A Eurobond is a debt security that pays interest and principal in a denomination other than the currency of the country it was issued in.
For example, suppose a Japanese company plans to build a factory in Canada. The company finds there’s Canadian demand for the Japanese Yen and decides to issue a Yen-paying bond in Canada to finance the factory. Canadian investors who buy this bond face currency (exchange rate) risk, which is the potential for loss related to currency conversion.
If the exchange rate between the Japanese Yen and Canadian Dollars changes, the Canadian investors could receive fewer Canadian Dollars when they convert their Yen-denominated interest payments (and the principal at maturity) back into Canadian Dollars. Currency risk would occur if the Japanese Yen weakened (which is the same as the Canadian Dollar strengthening). The weaker the Yen becomes, the fewer Canadian Dollars the investor receives upon conversion.
To summarize, currency risk occurs when:
*A currency’s strength or weakness is always compared to another currency. For example, the US Dollar is considered strong compared to the Vietnamese Dong. Stating the Dong is weak compared to the US Dollar is saying the same thing.
Currency risk generally occurs when an investor must convert one currency to another. In most circumstances, this risk isn’t a concern for American investors purchasing securities denominated in US Dollars.
However, an investor can still face a “second-degree” version of this risk. For example, a company with international sales (in many different currencies) may experience gains or losses due to exchange rate fluctuations. If currency movements significantly reduce the company’s earnings (profits), the stock price could fall.
A Eurodollar bond is a specific type of Eurobond that pays US Dollars. Specifically, it’s a debt security that pays interest and principal in US Dollars but is issued outside of the United States. Because the US Dollar is in demand globally, Eurodollar bonds are relatively popular worldwide.
They’re issued by many types of organizations, including:
American municipalities have a history of issuing Eurodollar bonds, but the federal government does not. Treasury securities are among the most demanded securities in the world. The US Government (the issuer of Treasuries) offers them at Treasury auction, which always occurs in the United States. Essentially, the US Government requires foreign investors to come to it. Therefore, the US Government does not technically issue Eurodollar bonds.
Eurodollar bonds can be attractive to an American issuer because the issuer faces no currency risk but can still access funding from foreign investors. From the issuer’s perspective, a domestically issued bond and a Eurobond are similar if both pay interest and principal in US Dollars.
Foreign issuers, however, face currency risk because they may need to convert from their primary currency into US Dollars to make interest and principal payments. Foreign investors can face similar risk when converting US Dollar bond proceeds into their home currency.
Sign up for free to take 15 quiz questions on this topic