Certificates of deposit (CDs)

While bank products are part of the financial world, many items sold by banks aren’t considered securities and therefore aren’t heavily tested on the Series 7 exam. A few bank products do overlap with securities concepts, though. You only need the basics of how these products work and how they may be used as investments.

Certificates of deposit (CDs) are similar to bonds, but they’re issued only by banks. A CD pays a fixed rate of return based on the principal deposited (similar to a bond’s par value). The bank accepts the deposit for a predetermined period, pays interest during the term, and then returns the principal at maturity.

Jumbo CDs, also known as negotiable CDs, are large-denomination CDs that can trade in the secondary market. They have a minimum denomination of $100,000, and denominations of $1 million or more are common. Because many retail investors can’t meet these minimums, financial institutions often buy jumbo CDs and repackage them into smaller products for retail customers. Since the minimum investment is larger, banks typically 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 a week. This short-term structure makes them useful for institutions that want to park large amounts of cash for brief periods. Typical institutional buyers include pension plans, mutual funds, and large corporations.

Like other bank products, jumbo CDs can be covered by FDIC insurance. FDIC insurance protects depositors against loss of funds due to bank failure. Without this insurance, investors with bank deposits or bank products could lose money if the bank went bankrupt. FDIC insurance is government-mandated coverage that banks pay for, and it covers customer deposits up to $250,000 per bank.

Jumbo CDs issued in denominations less than $250,000 have full FDIC coverage. Denominations above $250,000 are only partially covered.

Investors can also buy brokered CDs through brokerage firms. Instead of going directly to a bank, firms such as broker-dealers purchase large quantities of individual CDs and resell them to customers. Because the broker-dealer buys in bulk, it can often offer higher yields than a customer might receive 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 prior to maturity.

As long as the CD is titled in the customer’s name (which occurs upon purchase), the investor receives FDIC insurance up to $250,000 per bank. One advantage of brokered CDs is that you can spread deposits across multiple banks, since broker-dealers typically offer CDs from several different banks. For example, an investor who wants $1 million of FDIC coverage could buy four $250,000 CDs from four different banks. As long as the investor stays at or below $250,000 per bank, the deposits are fully insured.

Because CDs expose investors to relatively low risk, they generally offer relatively low yields compared with other debt securities. They’re most suitable for investors who want a safe place to hold cash.