What is a Negotiable Certificate of Deposit (NCD)?
A negotiable certificate of deposit (NCD) refers to a certificate of deposit with a minimum par value of $100,000, although typically, NCDs will carry a much higher face value. They are also known as jumbo CDs.
NCDs are guaranteed by a bank and can be traded in a highly-liquid secondary market. However, they cannot be redeemed before maturity. Because NCDs are so large, they are usually purchased by institutions and wealthy individual investors.
Understanding Certificate of Deposits
A certificate of deposit (CD) refers to a product extended by banks, credit unions, and other financial lenders to provide a specified interest rate to investors who leave a lump-sum deposit that cannot be withdrawn for a certain period of time.
Virtually all financial institutions offer CD products with varying interest rates and time lengths. CDs can be considered a much safer investment alternative than bonds, stocks, real estate, and other asset classes due to the predetermined interest rate that removes the volatility of returns.
Opening a CD is much like opening a standard bank account. The main difference is that a CD will lock in the following aspects:
- The interest rate: The specified interest rate is locked in
- The maturity term: The length of time that the funds are deposited are locked in
- The principal: The amount specified to be locked in cannot be changed
Advantages of Certificates of Deposit
- Certificates of deposits generally offer a higher interest rate than a savings account or money-market fund.
- There are very little risk and volatility associated with the return.
- For most financial institutions, it is guaranteed by the federal government.
Disadvantages of Certificates of Deposit
- A certificate of deposit cannot be liquidated before maturity without a penalty, and therefore, is very inflexible.
- CDs generally earn a lower return than other asset classes.
- The return is fixed and can perform relatively worse than other investments in a time period of rising interest rates.
Features of NCDs
Negotiable certificates of deposit usually come with short-term maturities, ranging from a few weeks to one year. Interest is paid either twice a year or at maturity. The interest rates are negotiable, and the yield is correlated with money market conditions.
NCDs are similar to regular CDs, but the main differences are:
- Large face value
- Negotiable aspect
In terms of face value, NCDs are more valuable than regular CDs. Although regular CDs can be on varying amounts of funds for regular retail investors, NCDs carry a face value of at least $100,000 and are usually much larger.
Because of the fact, NCDs are not a product purchased by retail investors. Instead, they are used by large institutions and high net-worth individuals as a cash management tool to make sure that cash use is being optimized.
NCD terms are much more negotiable than regular CDs. Generally, a regular retail investor has very little bargaining power when negotiating the terms of a CD. So, the terms of CDs are more dependent on market conditions and financial institutions.
However, large institutional investors and high net-worth individuals have much more bargaining power and can negotiate the terms more broadly with banks and financial institutions.
Advantages of NCDs
1. Low risk (and FDIC-insured)
NCDs are a favored investment product due to their low risk. In addition, NCDs are insured by the Federal Deposit Insurance Corporation (FDIC) in the U.S. The FDIC insures NCDs up to $250,000 per depositor in each bank.
2. More liquid
NCDs are much more liquid than regular CDs. A regular CD cannot be traded on a secondary market, and therefore, the funds are locked in unless an investor is willing to pay a penalty. However, NCDs have a highly liquid secondary market where an NCD holder can sell their NCD if they require liquidity.
NCDs generally offer a return for investors at a higher rate than Treasury bonds. Typically, the yield is higher as well.
Disadvantages of NCDs
1. Riskier than Treasury bills
NCDs are generally riskier than Treasury bills. It is due to the fact that the probability of a specific bank or financial institution defaulting is larger than the probability of default for the U.S government.
2. Can be callable in some cases
Most NCDs do not feature a call option, meaning that the financial institution that offers them cannot recall the certificate and pay back the funds early. However, some financial institutions do offer callable NCDs, which is a large risk for investors in a period of low interest rates. The financial institution can “call” the NCD and pay a much lower prevailing market interest rate to future lenders/investors.
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