Certificates of deposit (CDs)

While bank products are related to finance, many items sold by banks are not considered securities and therefore are not heavily tested on the Series 7 exam. However, some bank issues crossover into the world of securities. We’ll only need to know the basics of these products and how they may be utilized as investments.

Certificates of deposit (CDs) are very similar to bonds, but are only issued by banks. CDs pay a fixed rate of return based on the principal deposited, which is like the par value of the bond. The bank takes a deposit for a predetermined amount of time, pays interest, then pays the principal back at maturity. Does this sound familiar?

Jumbo CDs, also known as negotiable CDs, are large versions of CDs that are traded in the secondary market. With a minimum denomination of $100,000 and common denominations of $1 million or more, many retail investors cannot afford these investments. However, financial institutions purchase these and repackage them into smaller products to sell to retail investors. Because of the larger minimum investment, banks tend to offer higher rates on their jumbo CDs as compared to traditional CDs.

Jumbo CDs are typically short-term, with many maturing within one year or less from issuance. Some jumbo CDs last as short as a week. The short-term nature of these investments makes them suitable for large financial institutions looking to park large amounts of cash for short periods of time. Typical institutional investors that purchase jumbo CDs include pension plans, mutual funds, and large corporations.

Like other bank products, Jumbo CDs can be covered by FDIC insurance. FDIC insurance covers the loss of funds due to bank failure. Without this insurance, investors with bank deposits or owning bank products would lose their money if their bank went bankrupt. FDIC insurance is government-mandated insurance that banks must pay for; it covers customer deposits up to $250,000 per bank.

Jumbo CDs issued in denominations less than $250,000 will have full FDIC coverage, but denominations over this amount will only be partially covered.

Investors at brokerage firms can obtain brokered CDs. Instead of going directly to the bank, financial firms like broker-dealers buy large quantities of individual CDs and re-sell them to their own customers. Because the broker-dealer is buying in bulk from the bank, they commonly are able to obtain higher yields for their customers than if they (the customers) went directly to the bank. Brokered CDs have maturities all across the spectrum, spanning from as short as a month up to 30 years. Similar to jumbo CDs, brokered CDs are negotiable and can be traded in the secondary market prior to maturity.

As long as the CD is eventually titled in the customer’s name (which they all are upon purchase), the investor obtains FDIC insurance of up to $250,000 per bank. One of the advantages of brokered CDs is the ability to obtain more FDIC insurance due to broker-dealers typically offering brokered CDs from several different banks. If an investor wanted to obtain $1 million of FDIC insurance, they could buy four $250,000 CDs from four different banks. As long as they don’t exceed $250,000 per bank, they’re fully insured. Given the lack of risk CDs expose investors to, they provide relatively low yields (compared to other debt securities). They are most suitable for investors seeking a safe shelter for cash.