A CD is a negotiable money market instrument issued in dematerialized form against funds deposited in a bank or in any financial institution for a specified period of time at a market-determined discount rate. Dematerialization refers to the conversion of physical certificates of an investor to an equivalent number of securities in electronic form. CDs are one of the safest instruments as compared to other securities.
How do CDs work?
In simple words, CDs are a form of time deposits in which you keep your cash in the bank for a specified amount of time. In return for that promise, the bank agrees to pay you more than you would get from a savings account, you get a higher annual percentage yield. The banks pay more because they know they can use your money for longer-term investments like loans, and also that you won’t come to withdraw the funds. When you open a CD, you’ll choose how long you want to keep your funds locked up. This time period is called the term. After the maturity of the term of the CD, you will get the face value of the CD as well as interest earned for the term.
Who can issue a CD?
CD can be issued by:
- Scheduled commercial banks (excluding Regional Rural Banks and Local Area Banks); Banks have freedom to issue the amount from CDs depending on their funding requirements
- Selected All-India Financial Institutions (FIs) that have been permitted by RBI to raise short-term resources within the limit fixed by RBI.
Who can invest in CD?
- Companies (including banks and PDs)
- Trusts, funds, associations
- Non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-repatriable basis, which should be clearly stated on the Certificate
FEATURES OF CDs
The maturity period of CDs issued by banks should not be less than 7 days and not more than one year, from the date of issue. The Financial institutions can issue CDs for a period not less than 1 year and not be exceeding 3 years from the date of issue.
- Minimum size of issue and deposit
The minimum amount of CD issued and deposited by a single subscriber is Rs.100000. And it can be issued and deposited in multiples of Rs.100000 thereafter.
- There is no lock-in period for the CDs
CDs are freely transferable. CDs in a demat account can be transferred as per procedure applicable to other demat securities.
- Discount/ coupon rate
A CD can be issued at a discount on its face value. Banks/FIs can issue CDs on floating rate basis
Advantages of CDs
- Better returns than savings account: CDs offer a better return than the savings account. CDs are more valuable to banks than savings deposits because in case of CDs investors won’t come to withdraw their funds as it happens in a savings account. Investors prefer to keep a CD till its maturity because of a penalty fee charged due to early withdrawal.
- Wide selection: one can get CDs at different maturities and select the one that suits one’s requirement.
- Fixed and predictable return: one can be sure of getting a fixed return within a fixed period of time i.e. the returns are predictable.
Disadvantages of CDs
- Limited liquidity: CDs block the funds for a particular time period. Though the maximum term for investing in CD is for a year if you are in urgent need for funds then you can withdraw from CD but at a cost of paying a penalty charge that is capable to eat up your interest also. So CDs have limited liquidity.