Lesson 1 of 5
Certificates of deposit originated in the domestic US market (where they are directed primarily at the retail market). In the euromarket, however, CDs are very closely allied to interbank deposits.
A CD is a record evidencing the placement of a deposit with the CD issuer for a stated period of and at a given rate of interest. The CD therefore recognizes the obligation of the issuer to pay the principal (face value of the CD) plus interest to CD holder at maturity.
Originally, CDs were all issued on security paper and were high value bearer instruments that had to be collected by messenger from the issuer. However, it is now usual to issue CDs in electronic (book entry) from, and to use an international clearing system (e.g., Euroclear) to arrange the electronic book transfer and custody of the securities.
In London, there has also been the development o the CMO (Central Money Markets Office) at the Bank of England which safe keeps arranging electronic records of ownership. Eventually, this may lead to the virtual elimination of the paper CD.
In London, there has also been the development of the CMO (Central Money Markets Office) at the Bank of England which safekeeps CDs whilst arranging electronic records of ownership. Eventually, this may lead to the virtual elimination of the paper CD.
It is useful to compare a CD with an ordinary time deposit. With a time deposit, the depositor places a sum of money with a bank for a fixed time period. At maturity, the depositor can withdraw the money deposited plus interest.
A CD is a certificate for a time deposit: it is a bearer security, and the CD holder can sell the entitlement to someone else. The great advantage of a CD over a time deposit, to the CD holder is that it is a liquid negotiable instrument, tradeable in a secondary market. Hence, CDs provide a means for the holder to deposit funds short-term whilst retaining the flexibility to convert them into cash should the requirement arise.
In return for this liquidity, the CD holder must accept a lower yield than on a money market deposit. This is normally about 1/16th of 1% (6.25 basis points) or 1/8th of 1% (12. basis points) below the equivalent rate for a large deposit with the same bank.
Certificates of Deposit are issued in many centers around the world but the prime international centre is in London. The bank of England authorizes major banks to issue CDs in a variety of currencies, US dollars, yen, Australian dollars, Canadian dollars and ECUs. Certificates may be issued in other currencies too, provided the appropriate central bank is aware and des not object.
(Sterling CDs may also be issued by UK societies. However, the majority of CDs, whether issued by banks or building societies, are issued as part of normal money market funding arrangements).
Whilst most CDs issued are for a period of one, three or six months, some may be issued on request for broken periods (colloquially known as cock dates). Also, some CDs are issued as part of a formal programme under which one dealer or group of dealers undertakes to buy a large volume (and value) of CDs for onward sale. Often these CDs will be for periods in excess of one year, perhaps as long as 3 or 5 ears.
The Bank of England does not consider that an instrument issued for longer than 5 years is, at any time during its life, a CD. The maximum term for which London Certificate of Deposit are issued is therefore five years. CDs with an original life of greater than one year will pay interest at least annually. (There is no minimum maturity for a CD).