A certificate of deposit (CD) is a money market instrument issued by a depository institution as evidence of a time deposit. Small denomination certificates of deposit are issued to retail investors. In the United States, these usually are covered by deposit insurance. This article focuses on large-denomination certificates of deposit, which are issued to institutional investors for denominations generally exceeding $10 million.
A certificate of deposit has a fixed term. At the end of the term, the deposit is returned with interest. The vast majority of certificates of deposit have terms of under a year, with three months being typical. Certificates of deposit with terms of a year or more are called term CDs. Terms of five years are not unheard of.
Most certificates of deposit credit a fixed rate of interest, but there are also floating-rate certificates of deposit. A fee must be paid to withdraw funds early. Because most certificates of deposit are negotiable, investors usually sell an unwanted certificate of deposit rather than pay a fee and withdraw the funds. To facilitate transferability, most certificates of deposit are issued in bearer form, but some are registered.
Certificates of deposit fall into three general categories:
- Domestic CDs are issued within a country by a domestic bank or other depository institution.
- Foreign CDs are issued within a country by a domestic branch of a foreign depository institution. For example, a Yankee CD is a certificate of deposit issued in the United States by a foreign bank.
- Euro CDs are issued outside a country but are denominated in that country’s currency.
Domestic and foreign CDs are subject to the regulations of the country in which they are issued. Euro CDs are not. For this reason, Euro CDs have historically offered slightly higher yields.
Yields for terms less than a year are quoted as simple interest rates. An actual/360 basis is used almost everywhere, but certificates of deposit denominated in British pounds are usually quoted on an actual/365 basis. Yields depend primarily on a certificate of deposit’s term, the level of interest rates for the currency it is denominated in, and the credit quality of the issuer.
Depository institutions try to sell their certificates of deposit directly to investors. If their funding needs exceed their ability to directly market the certificates of deposit, they may also sell them to dealers, who then resell them. Dealers provide a secondary market in certificates of deposit. Brokers also arrange transactions. To preserve anonymity, inter-dealer transactions are often brokered.