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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 CD rates are better than a savings account, but are different in that the money can not be withdrawn until the end of the CD term.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

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Backwardation Definition

See Also:
Contango
Interest Rate
Efficient Market Theory
Market Dynamics
Arbitrage

Backwardation Definition

Backwardation is a term used to describe a commodities market when the spot rates are higher than the future price of that certain commodity. In other words there is a downward sloping forward curve relative to the spot rate set for maturity of the commodity. This is the opposite of a market that is in Contango.

Backwardation Explained

Backwardation has been seen in commodities like corn, wheat, or oil. A backwardation market usually occurs because farmers and other commodity producers would like to lock in a price so that they do not have to accept the risk of the fluctuations in the market. Many of these farmers will accept a current rate to mark a guaranteed price. The investors on the other hand will need to expect that the spot rate is actually higher so that they can lock in the current future price and make a profit.

Backwardation Example

Hal, a corn farmer in Nebraska, has been observing prices as of late to decide what he should do about his crop that is about to mature. Hal calculates that the future price of corn is around $6 per bushel. The spot rate at maturity is $8. However, Hal knows that this is never for sure. The market has been known to fluctuate the same amount the other way to $4 per bushel. Hal talks to some of his customers and locks in the future price of $6 to be sold when the crop matures. Because the customers believe the future spot rate to be correct they are happy to accept the $6 price. This way when they go to sell in the market they expect to make a profit of $2 per bushel.

backwardation definition

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