Certificates of Deposit (CDs)
Overview
Certificates of Deposit (CDs) are promissory arrangements between a depositor/investor and a bank, whereby the issuing bank agrees to pay a predetermined rate of interest in exchange for the investor agreeing to deposit funds for a fixed period of time. Typically, CDs offer a higher rate of interest than savings or money market deposit accounts, and are widely considered to be relatively low-risk investments because of the availability of deposit insurance by the FDIC. CDs are included as part of total deposits held at an FDIC-insured bank and are subject to coverage limits established by the FDIC.
CDs, which are offered in demoninations of $1,000, generally pay interest periodically (for example, every six months) with the principal amount being returned to investors at final maturity. Interest income from CDs is generally subject to income tax. There are two basic types of CDs: those traditionally offered at the local bank and brokered CDs available through a brokerage firm such as Morgan Keegan.
Brokered CDs
Investors should carefully consider the risks and benefits of both bank and brokered CDs in order to determine the most appropriate selection for their individual circumstances. A Morgan Keegan financial advisor can help you evaluate the various options.
Brokered CDs. With CDs offered through a Morgan Keegan brokerage account, investors can choose from a broad selection of maturities and coupon frequencies to find those CDs best-suited to their particular requirements. Unlike other types of investment securities which are not covered by FDIC insurance, all CDs offered by Morgan Keegan benefit from the same FDIC coverage as Bank CDs. It is important, however, to understand that not all CDs have FDIC insurance. Learn more about FDIC coverage of CDs.
Brokered CDs and the Secondary Market
An important distinction between Brokered CDs and Bank CDs is the different means for early redemption. Bank CDs typically allow investors an option for early withdrawal by charging an early withdrawal penalty when redeemed before maturity. By contrast, Brokered CDs are traded in the secondary market, which provides an opportunity for investors to sell their CDs at the prevailing market levels. As a result, the value of a Brokered CD sold in the secondary market may be worth more or less than the original amount invested, depending on market conditions.
CD StructureS Available Through Morgan Keegan
Fixed-Rate CDs. Considered the simplest (and most common) type of callable CD structure, the interest rate on a fixed-rate CD is set and remains constant until maturity or called.
Variable-Rate CDs provide an interest rate that is adjusted periodically in relation to some benchmark, such as the prime rate or a stock rate.
Step-Up CDs feature coupons that increase at intervals according to a pre-determined rate schedule until maturity or called.
Zero-Coupon CDs. Issued at a deep discount to par, zero-coupon CDs gradually accumulate interest due until they reach par at maturity and are retired. Investors who don’t need current income may prefer zero-coupon CDs.
Market-Index-Linked CDs pay interest based on the performance of a market index, rather than a fixed interest rate. No interest is earned or credited until maturity, which usually ranges from 5-10 years, allowing for short-term market volatility.
Other Considerations
Estate Feature. A valuable feature available with Morgan Keegan Brokered CDs is the survivor’s option, which is designed to protect estate assets. Upon the death of at least one of the beneficial owners, this provision allows the surviving heir (or estate) the right to redeem the CD from the issuer at par value plus accrued interest prior to the stated maturity date, regardless of the market value at the time the survivor option is exercised.
Callable. Callable CDs allow for the issuer to redeem, or call, a CD prior to its final maturity. When CDs are called, investors are paid principal, along with interest earned through the call date. Because the call option is likely to be exercised when interest rates have declined, callable CDs typically offer higher interest rates than non-callable CDs in order to compensate investors for the possibility that their deposit will be retired early.
Non-Callable. Most CDs are non-callable, meaning that the issuer is precluded from redeeming the deposit prior to its final maturity.
Educate Yourself Before Investing
Before considering the purchase of a CD from a bank or brokerage firm, make sure you fully understand all of its terms. Carefully read the disclosure statements, including any fine print.
Certificates of Deposit also carry certain risks to the investor, including: price risk; reinvestment risk; call risk; market risk, and prepayment risk. Learn more about these risks here.
