Certificate of Deposits

 

CDs are also called Certificates of Deposit. They are financial instruments….. We have heard this time and again. But what do CDs actually mean? Who issues them?? Who subscribes to them??? Let me explain this to you with an example…  example… 

 

• Say Amar wishes to borrow Rs. 30 Lakhs for  his new buiness venture by next week. • He goes to his bank to ask for the loan.

• But the bank to provide a at loan,though it realizes that itagrees has only Rs. 20 lacs present.

• Now thebank. bank does not wish to lose him to another • So the bank asks him to come back later to collect the loan amount at let‟s say 15%.  15%. 

 

So how does the bank provide the additional Rs.10 lakhs?

• The bank has corporate relationships from whom they can borrow. • In ord order er to bo borro rrow, w, the they y iss issue ue „C „Cert ertifi ificat cates es of  Deposit‟ to these corporate relationships who in turn subscribe to them. • Obviously the rate of interest offered by the bank to the corporate institutions would be higher than the regular fixed deposits. • Thus money comes into the bank and is offered to Amar.

 

• CDs, thus, become the financial instrument issued by banks at a higher interest rate than Fixed to in entice park moneyDeposits with them ordercorporates to meet a to lending need. •  A CD bears:  – a maturity date,  – a specified interest rate, and  – can be issued in any denomination. • CDs are generally issued by commercial banks. • The term of a CD usually ranges from fr om one month to five years.

 

How CDs Work! Borrower   Approaches Bank

Bank Lends Money

 

You may wonder why Amar did not raise money through CPs as he could have gained through dis-intermediation… dis-intermediation…   (Refer to previous lesson on CP)

 

This was not possible because: – Amar‟s organization was not very very well reputed which could issue highly rated “Corporate Papers”  – His only option was to go through his bank unlike well reputed organizations who can afford to go directly to the market to raise money.  – In other words,. Amar needed the intermediation provided by banks.

 

To Sum Up • What: A What: A Certificate of Deposit or  or CD CD   is a time deposit or a financial product commonly offered to consumers by banks. • Why: Sometimes, a bank may not have enough funds to provide a loan so it takes the help of CDs to provide a higher rate of interest to corporates. • When: The term of a CD generally ranges from one month to five years.

 

Between this and the previous lesson, I hope you have now understood the difference between T-Billa!!CD, a CP and a

• CD: Money raised by the bank from the market to service an outstanding loan. • CP: Money raised by a reputed corporate directly from the market by passing the bank for meeting working capital requirement ( short term borrowing). • T-Bill : Same to asmeet CP but governement its issued workingby capital needs.

 

  Hope you have now understood the concept of  Certificate of Deposits

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