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CERTIFICATES OF DEPOSITS. Presentation for the subject: Fixed Income Securities By Group No. 6. An Introduction. Introduced in 1989 in India. Fixed interest rates and fixed tenure instruments issued by banks and financial institutions.
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CERTIFICATES OF DEPOSITS Presentation for the subject: Fixed Income Securities By Group No. 6
An Introduction • Introduced in 1989 in India. • Fixed interest rates and fixed tenure instruments issued by banks and financial institutions. • Safe way to make investments for a short or medium period of time • A negotiable money market instrument issued in Demat form or as a Usance Promissory Notes. • Offers a term-based assured return to the owner.
Features • Can be issued by Scheduled Commercial Banks (Except RRBs and Co-operative Banks) and Selected Financial Institution (Permitted by RBI within the umbrella limit fixed by RBI). • Maturity: Min. 7 days to Max. 12 Months (for Banks) Min. 1 Year to Max. 3 Years (For Financial Institutions) • Issued in denominations of 1 Lacs and multiples of 1 lacs thereafter. • Can be issued to individuals (other than minors), corporations, companies, trusts, associations. • NRIs can also subscribe on non–repatriable basis.
Features • Loan against collateral of CD not permitted. • Buy Back of CD by Banks/ FIs before maturity is not permitted. • Interest rates can be Fixed or Floating. • Rated by approved rating agencies such as CARE, ICRA, CRISIL, and FITCH). • Issue of CDs is governed by various directives issued by RBI. • CRR/ SLR applicable on the issue prices in case of banks. • No lock-in period
Features • Physical CDs are freely transferable by endorsement and delivery. • Dematerialized CDs can be transferred as per the procedure applicable to other demat securities. • CDs may be issued at a discount on face value. • Security Aspects. • Issue of Duplicate CDs. The Guidelines including all above features, instructions and directives are issued by Reserve Bank of India vide Master Circular No. FMD. No. 38/02.08.003/200-10 Dated. 1st July 2009
Other Guidelines by RBI • Freeing of CDs from interest rate regulations in 1992. • Permitting selected financial institutions to issue CDs for a maturity period of 1 to 3 years. • Abolishing limits to CDs issuances as a certain proportion of average fortnightly outstanding aggregate deposits. (October 1993) • Reducing minimum issuance size from 1crore in 1989 to Rs 1 lakh in June 2002. • Withdrawal of restriction on minimum period for transferability. • Issuance of CDs only in dematerialized form (June 2002). • Permitting banks to issue floating rate CDs. (Oct 2002) • Lowering the minimum maturity period to 7days.(April 2005)
Buying of CDs • Return method is an important criteria before buying CD. • Returns can be based on Annual Percentage Yield (APY) or Annual Percentage Rate (APR). • In APY, interest earned is based on compounded interest calculation. • However, in APR method, simple interest calculation is done to generate the return.
Format Of CDs • Banks/FIs should issue CDs only in the dematerialized form. • Investors have option to seek CDs in physical form as per Depositories Act 1966. • Issuances of CDs in physical form will attract stamp duty. • No grace period for repayment of CDs. • If maturity date is a holiday, payment to be made on the immediate preceding working day.
Reporting to RBI • The amount of CDs issued should be reported to RBI on a fortnightly return basis. • To be submitted within 10 days from the end of the fortnight date.
Types of CDs Conventional CDs Callable CDs Brokered CDs Bump Up CDs Liquid CDs Step Up/ Step down CDs Variable Rate CDs Add on CDs Zero Coupon CDs Certificates of Deposits
Types of CDs Conventional CDs: • Fixed Maturity Date • Fixed Interest Rates Callable CDs: • The bank reserves the right to "call" the investment after the initial non-callable period. • Callable CDs pay a premium interest rate. Brokered CDs: • Brokerage firms can sometimes negotiate a higher rate of interest for a CD by promising to bring a certain number of deposits to the institution. • Instead of owning the entire CD, each investor owns a piece. • account records reflects that the broker is merely acting as an agent (e.g., "XYZ Brokerage as Custodian for Customers").
Types of CDs Bump Up CDs: • Allows the account holder to have the option to increase the interest rate once during the term of the CD. • The rate change does not change the original maturity date of the CD. Liquid CDs: • A fixed rate certificate of deposit, which allows to withdraw a portion of the original deposit during the term without paying a penalty. • There will be some limits on the amount that can be withdrawn and number of withdrawals. Step Up/ Step down CDs: • Have a fixed interest rate for a period of time, usually one year and then the interest rate automatically rises up to a predetermined rate or is lowered to a predetermined rate.
Types of CDs Variable Rate CDs: • Tied to the outcome of a market index. • The interest earned at maturity is based on the percentage gain (or loss) from the Initial Index to the final Index value. • Can be tied to a bond or stock index or a reference rate like the Treasury bills, Prime Rate or the Consumer Price Index. Add on CDs: • Fixed or variable rate CDs to which can make additional deposits. Zero Coupon CDs: • Issued at a substantial discount from the face amount of the CD. • The maturity terms are much longer, 15 to 20 years. • Do not pay interest until the maturity date.
Functioning of CDs Choosing A CD: • Besides the conventional CD that provides a fixed rate of interest (ROI), there is another type, called Callable CD. • ‘Calling’ here refers to a privilege enjoyed by the issuer to cancel the CD after a certain period of time, i.e. the CD can be ‘called’. Maturity of CDs • Financial institutions have different facilities on offer when a Certificate matures. • Automatically transfer the total amount on maturity from their CDs to the savings account in their name. • Automatically re-investing the amount due on maturity into a new CD. • Customers are reminded in advance about an impending CD that is about to mature.
Functioning of CDs Understanding Interest Rates • The common notion is that CDs offer a fixed rate of interest. • Most of the banks will offer only fixed ROI over a period of time. • Callable or Multi-step CDs may offer a bonus-centric interest rate. Interest Payment • At the time of maturity, the owner of a CD receives two things: the principal amount and the interest generated. • Interest that is earned on a monthly or annual basis. • Interest is accrued in the certificate account, along with the principal. (ROI is calculated on a compounded basis)
Functioning of CDs Ladders: • Longer terms may result in a loss of opportunity to lock in higher interest rates in a rising-rate economy. • Mitigation strategy for this is the "CD ladder" strategy. • The investor distributes the deposits over a period of several years (at higher rate), but in a way that part of it matures annually. • Reaps the benefits of the longest-term rates while retaining the option to re-invest or withdraw the money in shorter-term intervals. • The responsibility for maintaining the ladder falls on the depositor, not the financial institution. • Depositors are free to distribute a ladder strategy across more than one bank
Advantages of CDs • Offer a higher rate of interest than Treasury bills and savings account . • Return on investment is ensured despite the rate fluctuations in the market. • Insured by Federal Deposit Insurance Corporation • The return on CDs is assured and helps in financial planning. • Very easy to buy a CD. • CDs can be purchased and sold through a brokerage firm.
Disadvantages of CDs • Money is tied down for long durations of time. • As the rate of interest is fixed, it is difficult to change or to take advantage of the market situation when the market rates are favorable. • Though the return rate is higher on CDs than savings account, it is much lower than other money market instruments. • According to the federal regulations, FDIC will insure CDs up to the maximum amount of $100,000 in a single financial institution.
Conventional CDs • Low Minimum Deposits: • $ 5,000 minimum deposit for U.S. resident consumers and corporate customers • $ 10,000 minimum deposit for non-US resident consumers and corporate customers
Auto Renewal: • For maturities greater than one month, maturity notice is mailed not less than 14 days and not more than 30 days prior to the maturity date. • Automatically renewal of certificate of deposit for a period equal to the existing term, at the rate offered for that term on the maturity date. • CDs which are automatically renewed carry a 10-calendar-day grace period, including the maturity date for notifying the cancellation of CD and withdraw without incurring a premature withdrawal penalty.
Choice of Interest payment: • Choice between cumulative and non-cumulative interest payments. • In case of cumulative interest payments, interest is compounded at quarterly intervals and paid along with the principal at the time of maturity. • In case of non-cumulative, interest is credited to transaction account at quarterly intervals. • Interest and principal can be paid only to the account holders.
Early Withdrawals: • Deposits or withdrawals are not permissible before the maturity date. • In any case, when premature withdrawals are permitted, the following penalty will be imposed: The penalty is calculated at the interest rate which the CD is earning. The penalty is applied no matter how long the funds have been on deposit and may result in a reduction of the principal. A penalty is not charged if the account holder dies or is declared legally incompetent.
