A Certificate of Deposit (CD) is a negotiable instrument evidencing a deposit with a bank. Unlike a traditional bank deposit which is non-transferable, a CD is a marketable instrument so that the investor can dispose it off in the secondary market when cash is needed. The final holder is paid the face value on maturity along with the interest. CDs are issued in large denominations – $100,000 or equivalent or higher – and are used by commercial banks as short-term funding instruments. Occasionally, CDs with maturity exceeding one year are issued. When the maturity is less than a year, interest is paid along with redemption of principal; for maturity longer than a year, interest may be paid semiannually., Euro CDs are issued mainly in London by banks. Interest on CDs with maturity exceeding a year is paid annually rather than semiannually. There are floating rate CDs with maturities normally ranging from 18 months to five years on which interest rate is periodically reset, indexed to LIB OR, Federal Reserve CD composite rate, Treasury Bill rate and so forth.
This is an instrument widely used in the US money market to finance domestic as well as international trade. In a typical international trade transaction, the seller(exporter) draws a time or “usance” draft on the buyer’s (importer’s) bank. On completing the shipment, the exporter hands over the shipping documents and the letter of credit issued by the importer’s bank to its bank. The exporter gets paid the discounted value of the draft. The exporter’s bank presents the draft to the importer’s bank which stamps it as “accepted”. A banker’s acceptance is created. The exporter’s bank may hold the draft in its portfolio, ask the importer’s bank to rediscount it or sell it as a money market instrument. The investor might be a money market mutual fund. It is possible to draw BAs without a formal pre-authorization like a letter of credit as in this example.
In addition to these securitized instruments, short-term bank loans are also available. The euro currencies market is essentially an interbank deposit and loans market. Loans ranging in maturity from overnight to one year can be arranged with minimal formalities. Interest rates are indexed to LIB OR.
In the US money market, Repurchase Obligations (REPOS) are used by securities dealers to finance their holdings of securities. This is a form of collateralized short term borrowing in which the borrower “sells” securities to the lender with an agreement to “buy” them back at a later time.(Hence the name “Repurchase Obligations”). The repurchase price is the same as the original buying price, but the seller (borrower) pays interest in addition to buying back the securities. The duration for the borrowing may be as short as overnight or as long as up to a year. The former are called “overnight repos”; longer duration repos are “term repos”. The interest rate is determined by the demand-supply conditions.