Tag Archives | certificate of deposit

Term Deposit

See Also:
Loan Term
5 C’s of Credit (5 C’s of Banking)
How to manage your banking relationship
Bank Charge
Financial Instruments

Term Deposit Definition

A term deposit, also referred to as a time deposit or a certificate of deposit (CD), is an amount of money invested into a financial institution for a set amount of time or term period. Interest and withdrawal terms are sometimes negotiable because there are at times penalties with early withdrawals.

Term Deposits Explained

Term deposits are often short-term investments individuals make into a bank or other financial institution. Because of there short-term nature, consider time deposits one of the safest investments in the marketplace. Another advantage for an investor is the ability to invest at a higher interest rate than a normal savings account.

Term deposit disadvantages include the fact that a company or individual cannot touch or withdraw the fixed amount until the term is up without suffering a penalty. Smaller denominations under $100,000 usually contain contracts that are pre-established, with a certain amount of penalties if the deposit is withdrawn, interest rates are non-negotiable, and the amount of time in which the individual or company wishes to invest. Larger denominations or deposits above $100,000 are often negotiable. This means that the company or individual will negotiate the penalties for withdrawal, rate at which the money will be invested and the term or time period that the investor wants to pursue in his/her/its investment strategy.

Term Deposit Example

Company X has just received $1 million cash in its receivables from a customer. Company X also owes Company Y $800,000 in accounts payable for supplies that X used to manufacture its products. However, the payables are not due for another 3 months to Y. Therefore X has decided to put the $800,000 aside into a certificate of deposit (CD) for 3 months at a rate 5% which is higher than the savings account rate of 3.5%. Thus by the end of the 3 months X will have a profit of $10,000 (3/12 * 5% * $800,000). By holding the cash owed to Y and investing in a term deposit X has earned an extra $10,000.

term deposit

Share this:
0

Hot Money

See Also:
Effective Rate of Interest Calculation
Fixed Interest Rate vs Floating Interest Rate
Interest Rate
Nominal Interest Rate
Term Deposit

Hot Money Definition

Hot money refers to the cash that investors from foreign countries will invest during the short term in search of the highest interest rate possible. Normally, you do this through term deposits or certificates of deposit (CDs).

Hot Money Meaning

Hot money flows usually occur when one country can provide a higher interest rate than the one where the investor currently lives or conducts business. Often times these investors will invest in short term deposits like CDs. Then they will jump the funds from bank to bank if they can obtain a higher interest rate. Sometimes they will even do this if there is a penalty involved in withdrawing the funds like in a CD. This would only occur if the interest rate at another institution were dramatically higher to cover the cost of withdrawing the funds.

Hot Money Example

Kawahonda is a hot money investor from Japan and is looking to aggressively invest $100,000 he currently has sitting in a savings account in Japan earning 1%. He begins looking in the United States, and finds that he can earn 5% in short term CDs. He immediately contacts a bank in the United States and deposits the $100,000 in a 3 month CD. There is a 1% penalty if Kawahonda were to withdraw his funds early. After a month invested in the CD Kawahonda finds another bank in the U.S. that offers a CD that pays 8%. Kawahonda immediately withdraws the $100,000 and invest the money in a 6 month CD. at the end of the six month period Kawahonda will have earned:

$100,000 +($100,000 * 1/12 *.05) = $100,417 = amount earned in original CD

$100,417 – ($100,000 *.01) = $99,417 = amount after penalty is assessed

99,417 + ($99,417 * 6/12 * .08) = 103,394 = amount earned in 8% CD

Note: By investing in the higher interest paying CD Kawahonda is able to make $2,144($103,394 – $101,250) more even with the penalty. It is also $2,894 ($103,394 – $100,500) more than if Kawahonda kept is money in his savings account domestically.

hot money

Share this:
0

Financial Instruments

See Also:
What is a Bond
Required Rate of Return
Return on Asset
Commercial Paper
Hedging Risk
Histogram

Financial Instruments and Securities

Financial instruments are contracts that represent value. They come in many varieties. In fact, financial managers and bankers have a lot of leeway in creating and issuing financial instruments. The Securities and Exchange Commission (SEC) regulates publicly traded financial instruments; however, the SEC less stringently regulates private placement instruments. Most financial instruments fall into one or more of the following five categories: money market instruments, debt securities, equity securities, derivative instruments, and foreign exchange instruments.


Download The Free Know Your Economics Worksheet


Money Market Instruments

Money market instruments are highly marketable short-term debt securities. Furthermore, money market instruments are generally low-risk investments. Because of this, they offer yields that are lower than riskier stocks and financial instruments.

Often, investors trade money market instruments in large denominations among institutional investors. However, some money market instruments are available to individual investors via money market funds, or mutual funds that pool money market instruments.

Money market instruments include treasury bills, repurchase agreements, certificates of deposit, commercial paper, bankers’ acceptances, Eurodollars, and federal funds.

Debt Securities

Debt securities are longer-term debt instruments. With debt instruments, the issuer is essentially borrowing money from the investor. The investor plays the role of a lender lending money to the issuing entity. Longer-term debt securities often yield higher returns than money market instruments. Debt instruments also represent a claim on the assets of the issuing entity.

Debt securities are often called fixed-income securities. This is because the investor or lender often predetermines the terms of the debt instrument. For example, a debt instrument will be issued with a certain maturity, a certain principal amount, and a set coupon rate. However, while debt securities are often called fixed-income securities, this does not mean they yield a fixed stream of payments – debt securities’ returns can fluctuate and vary.

Examples of debt securities include: treasury notes, treasury bonds, inflation-protected treasury bonds, federal agency debt, international bonds, municipal bonds, corporate bonds, junk bonds, mortgages, mortgage-backed securities, and other types of debt.

Equity Securities

Equity securities represent shares of ownership in a company. In addition, equity securities often come with voting rights. They represent the shareholders’ interest in the issuing company and a residual claim on the company’s assets. This means if the issuing company goes bankrupt and has its assets liquidated, then the equity holders only get their money back after all other relevant claimants have been paid what they are owed.

Equity securities may be traded publicly on stock exchanges, they may be traded in over-the-counter (OTC) transactions, or they may be exchanged and held privately. Types of equity securities include common stock, preferred stock, and American Depository Receipts (ADR).

Financial Derivative Instruments

A financial derivative instrument is a contract that derives its value from an underlying asset or factor. In short, the value of a derivative depends on the value of something else. When the value of the underlying factor changes, the value of the derivative instrument also changes. Derivatives are often used for speculation, for leveraging a position, or for hedging risk.

Common derivatives include futures, forwards, options, and swaps. Common underlying assets or factors include stocks, bonds, currency exchange rates, commodity prices, market indices, and interest rates. However, derivatives can derive their value from almost anything, including weather data and political election outcomes.

Foreign Exchange Instruments

Another category of financial instruments is foreign exchange instruments. These are contracts involving different currencies. There are many currencies in the world, and there are several different instruments commonly used to trade in currencies.

The value of one currency relative to another depends on the exchange rate between the two currencies. Consider exchange rates either fixed or floating. Types of foreign exchange instruments include spot contracts, forward contracts, options, futures, and swaps.

Exchange foreign currencies for investment and speculative purposes and for hedging risk. You can trade foreign currencies all over the world twenty-four hours a day via banks and brokerages. The foreign exchange market is the largest market in the world. Consider speculating in foreign exchange markets very risky.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

financial instruments, money market instruments

Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

financial instruments, money market instruments

Share this:
0

Commercial Bank

See Also:
Investment Banks
5 C’s of Credit (5 C’s of Banking)
Categories of Banks
Bank Statement
How to manage your banking relationship.
Certificate of Deposit (CD)
Personal Credit for Commercial Loan
Alternative Forms of Financing
What Your Banker Wants You to Know

Commercial Bank Definition

Commercial banks are the most unrestricted and common of the different bank forms. A commercial bank is often considered a financial intermediary for transactions involving anything from a savings account to a certificate of deposit (CD).

Commercial Bank Meaning

A commercial bank often deals with daily transactions between checking and savings accounts. But they also deal with term deposits and money market accounts. These banks in the past was not allowed to take part in the capital markets under the Glass-Steagall Act. This activity was typically performed by investment banks. However, since the repeal of the act there has been less and less division between the two groups.

Commercial banks create money when they accept money from businesses or individuals owning a savings account, checking account, or a CD. It then loans these funds to businesses or individuals. It makes its profit by accepting interest payments.

This means that unlike most institutions, a bank’s assets are loans and bonds that it issues, while its liabilities are the savings and checking accounts along with other deposits. This is because these liabilities are payable on demand from the account holder unless it is a term deposit in which it is payable at the end of the term.

This is also why the Federal Reserve requires commercial bank reserves to ensure that a bank always has the proper amount of funds to meet its liabilities. This commercial bank regulation came after scares during the depression in which commercial banks were unable to meet their liabilities. This is why every bank is also required to carry Federal Deposit Insurance through the Federal Deposit Insurance Corporation (FDIC).

Learn how you can be the best wingman with our free How to be a Wingman guide!

commercial bank

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

commercial bank

Share this:
0

Certificate of Deposit (CD)

See Also:
Loan Term
Commercial Paper
Term Deposit
Treasury Bills (t bills)
Federal Funds Rate Definition

Certificate of Deposit (CD) Definition

A Certificate of Deposit or CD is a special type of time deposit used by many financial institutions, usually a commercial bank. Certificates of deposit generally offer fixed rates of return for periods of 1 month, 3 months, 6 months, 1 year, or more depending on the investor’s preference.

Certificate of Deposit (CD) Explained

A Certificate of Deposit is generally used by investors who need a short term arrangement to earn a fixed return. CD rates are better than a savings account, but are different in that the money can not be withdrawn until the end of the CD term. Certificate of deposit early withdrawal will cost the investor to pay a large penalty. This means that the investor must be absolutely sure the funds can remain untouched until the certificate of deposit maturity.

Certificates of deposit risks are generally restricted to the early withdrawal because it is unlikely that any of the financial institutions will default on CDs because of their short term nature. CDs that are denominated in $100,000 and above are referred to as negotiable certificates of deposit. This allows the investor to determine the penalty of early withdrawal as well as the rate of return. Other terms can also be calculated into the negotiable CD.

Certificate of Deposit (CD) Example

Bob has $1,000 in a savings account, but he would like to earn a greater return than the 0.5%. Bob goes to his bank and decides that he would like to invest his funds into a certificate of deposit so that he might earn a more meaningful return from the bank. The bank offers CD terms of 1.35% for a 3 month period. Bob decides to go forward with the agreement and at the end of the 3 month term he has earned interest of $3.38. This number is opposed to the $1.25 that would have been earned had Bob stayed with the savings account.

certificate of deposit

Share this:
0



See Dates