ANSWERS: 1
  • A certificate of deposit, or CD, is a special type of savings account offering higher than normal interest rates. Investors purchase certificates of deposit for fixed sums and allow them to mature for an agreed amount of time, with early withdrawals resulting in financial penalty. Banks may add a "call" feature to a certificate of deposit to give them greater control over changes in interest rates.

    Use

    A call option allows banks to call in certificates of deposit before they reach full maturity, thus ending the agreement.

    Function

    Banks place call options on certificates of deposit to take advantage of falling interest rates. For instance, if the interest rates drop, banks can call in the certificate of deposit and then sell the same CD to someone else at a lower interest rate. The call option rests solely with the bank and not the investor.

    Time Frame

    While the terms and length of call certificates of deposit vary, most are secure for the first year, with banks able to activate the call option only after 12 months.

    Benefits

    Investors also benefit from call certificates of deposit, receiving higher interest rates than standard CDs in exchange for adding the call risk.

    Considerations

    If the bank uses its call option on a certificate of deposit, the investor may decide to retain the CD, although she will do so at the lower interest rate. Otherwise, the investor will receive her original principal and all interest accrued to that point.

    Source:

    PNC.com

    FDIC.gov

    Investopedia.com

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