CDs

Definition

CDs, or Certificates of Deposit, are a type of savings account offered by banks and credit unions that provide a fixed interest rate in exchange for keeping a lump sum of money deposited for a predetermined period of time. They are considered a low-risk investment option that offers higher interest rates compared to traditional savings accounts.

5 Must Know Facts For Your Next Test

1. CDs typically offer higher interest rates than traditional savings accounts, making them a popular choice for short-term savings or emergency funds.
2. The interest rate on a CD is fixed for the duration of the term, which can range from a few months to several years, providing a predictable return on investment.
3. CDs are considered a low-risk investment option because they are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per institution.
4. Early withdrawal from a CD may result in a penalty, which can be a percentage of the principal or the interest earned, depending on the bank's policies.
5. CDs can be a useful tool for cash management by providing a safe and secure place to store funds that are not needed for immediate use.

Review Questions

• Explain how CDs can be used as a cash management tool within the context of 19.3 Cash Management.
  • Within the context of 19.3 Cash Management, CDs can be a valuable tool for managing cash. CDs offer a fixed interest rate and a predetermined maturity date, which allows individuals or businesses to set aside funds that are not needed for immediate use. The higher interest rates compared to traditional savings accounts can help maximize the return on these idle cash balances, while the low-risk nature of CDs provides a secure place to store the funds until they are needed. By laddering CDs with different maturity dates, individuals or businesses can ensure a steady stream of cash flow and manage their liquidity more effectively.
• Describe the key features of CDs that make them a suitable investment option for cash management purposes.
  • The key features of CDs that make them a suitable investment option for cash management purposes include their fixed interest rate, predetermined maturity date, and low-risk profile. The fixed interest rate provides a predictable return on investment, which is important for managing cash flow and budgeting. The predetermined maturity date allows individuals or businesses to plan for when the funds will be available, making it easier to coordinate with their cash needs. Additionally, the low-risk nature of CDs, as they are insured by the FDIC, makes them a safe place to store excess cash that is not needed for immediate use.
• Analyze how the use of CDs can help optimize a company's cash management strategies within the context of 19.3 Cash Management.
  • Within the context of 19.3 Cash Management, the use of CDs can help optimize a company's cash management strategies in several ways. By investing excess cash in CDs, companies can earn a higher interest rate than traditional savings accounts, which can contribute to their overall profitability. The fixed interest rate and predetermined maturity date of CDs also allow companies to better forecast and manage their cash flow, ensuring they have the necessary funds available when needed. Additionally, the low-risk nature of CDs, as they are FDIC-insured, provides a secure place to store cash reserves that can be accessed as needed, without the volatility associated with other investment options. By incorporating CDs into their cash management strategies, companies can improve their liquidity, maximize their returns on idle cash balances, and better align their cash flow with their operational and financial needs.

Related terms

Interest Rate: The annual percentage rate (APR) paid on the principal amount of a CD, which is fixed for the duration of the CD term.

Maturity Date: The date when the CD term ends, and the depositor can withdraw the principal and accrued interest without penalty.

Early Withdrawal Penalty: A fee charged by the bank if the depositor withdraws funds from a CD before the maturity date, which is typically a percentage of the principal or the interest earned.