certificate of deposit

What It Is

A certificate of deposit (CD) is a relatively low-risk debt instrument purchased directly through a commercial bank or savings and loan institution.

How It Works

The certificate of deposit indicates that the investor has deposited a sum of money for specified period of time and at a specified rate of interest. CD rates, terms and dollar amounts will vary from institution to institution. CDs are not publicly traded securities. As such, you will not find them traded on any exchange. You can also purchase CDs through a stockbroker. Because brokers have access to CDs from many institutions across the country, investors have more choices in regard to terms and yield. Many brokers do not charge investors a fee for CDs. Instead, they usually receive a commission from the issuing bank. Since brokered CDs are still bank CDs, they are insured by the FDIC (Federal Deposit Insurance Corp). up to $250,000.

Why It Matters

A CD is especially beneficial for a risk-averse investor who is looking to save and will not need funds until the instrument reaches maturity. Attributes of CDs making them favorable to such investors include:

An excellent short- to medium-term investment (typically from three months to seven years).
A higher rate of return than traditional money market accounts.
The FDIC insures CDs for up to $100,000. FDIC Insurance covers both principal and accrued interest.

While disadvantages are:

Investors can redeem bank-issued CDs prior to maturity. However, you will typically be charged an early withdrawal penalty. These penalties are set by each bank and differ nationwide.
Unlike Treasury notes, the interest on CDs is not exempt from state and local taxes. CDs are fully taxable at the state, local and federal levels.
The investment is locked in at a specific rate, even if interest rates increase.

Source: Investing Answers