When you think about a fixed-return investment, most people will suggest a Bank’s fixed deposit. However, several other secured options provide an assured return upon maturity other than Fixed Deposit Accounts.
A certificate of deposit is an ideal money market instrument for fixed returns against short and mid-term investments. You can learn more about its purpose, features, benefits, etc. in the section below.
Certificate of Deposit (CD) is issued by the RBI (Reserve Bank of India) in a dematerialised form. It is a financial instrument with fixed-income facilities and assured payout from the beginning. Both Scheduled Commercial Bank and All-India Financial Institutions are authorised to issue a CD at a discount on its face value. You cannot withdraw the deposited sum before the decided tenure. In case you need to withdraw the deposit, you need to pay a penalty.
The purpose of a CD is to provide a certificate to the individual denoting the amount of money he/she has deposited for the specific tenure. It also includes the declaration that the bank will pay interest to the individual depending on the deposited amount and tenure.
You need to understand the features of a certificate of deposit (CD) before investing in it. Here are they:
The Reserve Bank of India states that every individual, whether associated with a small-scale business or large-scale business, is eligible to invest in a certificate of deposit.
The maturity period of a CD can range between 7 days and 1 year when issued by commercial banks. However, for other financial institutions, the maturity period ranges from 1 year to 3 years.
A single issuer can invest a minimum of Rs. 1 lakh and its multiples under certificate deposit or CD.
Electronic or dematerialised certificates are eligible for delivery or endorsement transfers. However, demat form certificates should be transferred following the guidelines of Demat securities.
You can avail a discount on the face value of the CD. Besides, financial institutions and banks issue certificates of deposit on a floating rate basis.
The Reserve Bank of India permits some scheduled commercial banks and All-India Financial Institutions to issue CDs (certificate of deposits). However, Local Area Banks and Regional Rural Banks are excluded from this list.
The certificate of deposit offerings of each bank differs from the other in terms of interest rates and other factors. CD offers a higher interest rate than savings accounts or some other fixed term financial products. This is because you cannot withdraw a certificate of deposit or re-sold it before the decided period.
There's no difference between opening a bank deposit account and a certificate of deposit account. However, the following factors may differentiate a CD from other financial products:
When you sign for a CD, you agree to lock the deposited amount for a specific interest rate. Though the interest rate may change depending on market fluctuations, in the case of CDs it depends on the rate set by a specific country’s central banks. This is because CDs are held for short periods with a maturity period of 1 to 3 years maximum.
You need to invest a minimum of Rs.1 lakh to initiate investing in a certificate deposit (CD). However, you can increase the investment amount in multiples of Rs.1 lakh as per your convenience.
If you open a certificate deposit in a commercial bank, the maturity period will range from 7 days to 1 year. However, for other financial institutions, the maturity period ranges from 1 year to 3 years.
The deposit tenure for certificates of deposits issued by commercial banks is between 3 months and 12 months. However, financial institutions issue certificate of deposits for a tenure of 1 to 3 years.
You can buy and sell a certificate of deposit just like buying and selling shares. Take a look at the steps to buy a CD for better understanding:
You can seek professional assistance while buying a commercial deposit to avoid any inconveniences.
Let’s assume that a scheduled commercial bank has issued a commercial deposit of Rs.10 lakh for a maturity period of 91 days at an interest rate of 6.5%. the denomination eligible for this deposit is Rs.1 lakh. If you purchase one unit of this CD by investing Rs.1 lakh, what will be your returns?
Let’s calculate the returns in a simple interest formula:
P x R x T = Interest
Here, P stands for Principal, R for rate of interest, and T for time. So, the calculation goes as follows:
1,00,000 x 6.5% x (91/365) = 1,620.54
The total amount you will receive upon maturity = Principal + Interest
Total amount = Rs.1,00,000 + Rs.1,621 (approx.)
Therefore, after the maturity period of 91 days, you will earn a maturity amount of Rs.1,01,621 of the CD.
Here are the advantages of issuing a certificate of deposit:
The risks and returns associated with certificate of deposits are as follows:
When you are investing in a certificate of deposits as a savings tool, you should consider the interest rates. A high-interest rate will yield you a better return on cash deposits, while a low interest rate will affect your certificate of deposit’s growth.
However, you cannot take advantage of the higher interest rate without a bump-up or step-up CD. You can lock in savings at a fixed rate, so it carries the interest rate risks.
When inflation rises, the rate of interest you are earning on certificates of deposits can be affected, especially in case of a low-interest rate. Therefore, even if your savings are increasing, they will not grow favourably when it’s time to spend your savings.
Being a safer investment instrument, the returns you earn from a certificate of deposit are lower compared to investment options. However, the returns offered by a certificate of deposits are assured and stable. So, you can not expect a faster and higher return like stocks or mutual fund investments.
If you are looking for higher returns, you can invest in other investment schemes. They will offer higher returns while keeping pace with inflation. However, they are prone to market risks and volatility. So, you cannot expect an assured return.
Commercial paper and certificate of deposit are different in two aspects. Firstly, banks and financial institutions issue certificates of deposit, but large corporations, primary dealers, and All-India Financial Institutions issue commercial papers.
Secondly, you need to make a minimum investment of Rs.1 lakh and its multiples in certificate of deposits. However, the minimum investment amount for commercial paper is Rs.5 lakhs and thereafter in multiples.
With a certificate of deposits, you can earn assured returns by investing in short to medium-term. You can proceed with investing in a certificate of deposit after checking the features and benefits stated above. Besides, you need to open a demat account to hold the deposit.