Negotiable certificate of deposit

Negotiable certificate of deposit
See also

Negotiable certificate of deposit is a receipt issued by a commercial bank for the deposit of funds. Banks issue negotiable Certificate of Deposit (CD) in order to attract additional funds to make available to borrowers or to counteract the restrictive effect of the withdrawal of deposits from the bank[1].

The receipt stipulates that the bearer will receive annual interest payments of a specified magnitude and, at maturity, will receive a lump sum equal to the original principal. The certificate may not ordinarily be redeemed for cash by the bank prior to maturity. Hence, the name "negotiable" CD's[2].

Negotiable CD's are one of the more popular money market instruments for institutional investors. The maturities on negotiable CD's generally range from 3 to 18 months, although most have original maturities of 6 months or less. CD's issued with maturities greater than one year are called term CD's. CDs are interest-bearing notes, usually sold at their face value, with the principal and interest paid at maturity if the CD is less than one year and semiannually if it is a term CD[3].

Example of negotiable CD

The impetus for the initial establishment of negotiable CD's in the early 1960s resulted from an increase in money market interest rates, which caused many corporations to withdraw funds held in banks in order to purchase high-yielding commercial paper, treasury bills, and other money market instruments. Banks issued the new instrument - negotiable certificate of deposits[4]:

  • Negotiable certificate of deposits are held by units with a need for a temporary investment outlet for large amounts of funds, often in excess of $1 million. The primary buyers of CD's include business corporations, government institutions charitable organizations, and foreign buyers.
  • When credit demands escalate, the volume of negotiable CD's outstanding typically expands.

Origins of certificate of deposit

Certificates of Deposit were first issued in 1961 in commercial banks in the USA. Before this, U.S. banks had issued registered, non-negotiable certificates of deposit, which had limited appeal. The incentive for introducing a negotiable instrument was Federal Reserve Regulation Q which limited the interest rates that banks could offer on time and savings deposits. As interest rates in the money markets rose above Regulation Q levels, bank lost deposits to non-banks such as money market funds, which were not subject to this regulation. Deposits of 100,000 dollars or more and with a minimum tenor or maturity of 14 days were exempt from Regulation Q, but investors managing overnight and short term funds needed liquidity by being able to sell holdings of CDs in a secondary market. The first issues of CDs in London were made in 1966 in U.S. dollars[5].

References

Footnotes

  1. Perminder K., (2005)
  2. Perminder K., (2005)
  3. Stafford R. J., (2013)
  4. Perminder K., (2005)
  5. Stafford R. J., (2000)

Author: Piotr Tarsa