What is a Certificate Of Deposit: Rates, Minimum Amount, Maturity Period, Benefits, Example

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.

What Is a Certificate of Deposit? 

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.

Purpose of Certificate of Deposit

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. 

Features of Certificate of Deposit

You need to understand the features of a certificate of deposit (CD) before investing in it. Here are they:

• Eligibility Criteria

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.

• Maturity Period

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.

• Minimum investment amount

A single issuer can invest a minimum of Rs. 5 lakh and its multiples under certificate deposit or CD.

• Transferability

Electronic or dematerialised certificates are eligible for delivery or endorsement transfers. However, demat form certificates should be transferred following the guidelines of Demat securities. 

• Discount Offered

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.

Who Issues Certificate of Deposit?

The Reserve Bank of India permits Scheduled Commercial Banks, Regional Rural Banks, Small Finance Banks and All-India Financial Institutions to issue CDs (certificate of deposits). 

How Certificates of Deposit Work?

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:

• Principal
• Interest rate
• Institution
• The term, or length of deposit

Certificate of Deposit Interest Rates

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.

Certificate of Deposit Minimum Balance

You need to invest a minimum of Rs.5 lakh to initiate investing in a certificate deposit (CD). However, you can increase the investment amount in multiples of Rs.5 lakh as per your convenience.  

Certificate of Deposit Maturity Period

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. 

Certificate of Deposit Tenure

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.

How to Buy a Certificate of Deposit?

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:

1. Both the buyer and seller should agree on the quality and price of transactions involved in the CD.
2. The sellers issue a delivery instruction slip to authorise their depository participants.
3. This slip facilitates the transfer of CD to the buyer's account and includes instructions related to debiting the seller’s account.

You can seek professional assistance while buying a commercial deposit to avoid any inconveniences.

Certificate of Deposit Example

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.5 lakh. If you purchase one unit of this CD by investing Rs.5 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:

5,00,000 x 6.5% x (91/365) = 8,102.73  

The total amount you will receive upon maturity = Principal + Interest

Total amount = Rs.5,00,000 + Rs.8,102.73 (approx.)

= Rs.5,08,102.73

Therefore, after the maturity period of 91 days, you will earn a maturity amount of Rs.5,08,102.73 of the CD.

Certificate of Deposit Benefits

Here are the advantages of issuing a certificate of deposit:

• You can avail monthly, annual, or lump sum payouts in CDs during the withdrawal after completion of maturity period. The bank will help customise the investment instruments according to your needs. So, you can select the investment tenure, principal amount, and other parameters as per your feasibility.
• When you invest in a certificate of deposit, you can rest assured that the deposited amount is not subjected to market volatility. It remains completely secure, and you can earn assured returns on maturity. Besides, in case of lump sum investment, CDs offer larger interest rates to the investors.
• When you invest in a certificate of deposit, you only need to pay the investment amount. There are no additional costs while investing in CDs.

Certificate of Deposit Risk and Return

The risks and returns associated with certificate of deposits are as follows:

• Interest Rate Risk

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.

• Inflation Risk

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.   

• Lower Returns

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. 

Difference Between Commercial Paper and Certificate of Deposit

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.

Final Word

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. 

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