The impact of financial crisis on certificate of deposit - Free Essay Example

A certificate of Deposit or CD is a time deposit, a financial product equally offered to consumers by banks, thrift institutions, and credit unions. CDs are similar to savings accounts in that they are insured and thus virtually risk-free; they are money in the bank. They are different from savings accounts in that the CD has a specific, fixed term and, usually, a fixed interest rate. It is intended that the CD be held until maturity, at which time the money may be withdrawn together with the accrued interest. In exchange for keeping the money on deposit for the agreed-on term, institutions usually grant higher interest rates than they do on accounts from which money may be withdrawn on demand, although this may not be the case in an inverted yield curve situation. Fixed rates are common, but some institutions offer CDs with various forms of variable rates. For example, in mid-2004, interest rates were expected to rise, many banks and credit unions began to offer CDs with a bump-up feature. These allow for a single readjustment of the interest rate, at a time of the consumers choosing, during the term of the CD. Sometimes, CDs that are indexed to the stock market, the bond market, or other indices are introduced. How does CDs work? CDs typically require a minimum deposit, and may offer higher rates for larger deposits. In the US, the best rates are generally offered on Jumbo CDs with minimum deposits of $100,000. However there are also institutions that do the opposite and offer lower rates for their Jumbo CDs. The consumer who opens a CD may receive a passbook or paper certificate, it now is common for a CD to consist simply of a book entry and an item shown in the consumers periodic bank statements; that is, there is usually no certificate as such. Interest Payout At most institutions, the CD purchaser can arrange to have the interest periodically mailed as a check or transferred into a checking or savings account. This reduces total yield because there is no compounding. Some institutions allow the customer to select this option only at the time the CD is opened. 2. Closing a CD Withdrawals before maturity are usually subject to a substantial penalty. For a five-year CD, this is often the loss of six months interest. These penalties ensure that it is generally not in a holders best interest to withdraw the money before maturity-unless the holder has another investment with significantly higher return or has a serious need for the money. Commonly, institutions mail a notice to the CD holder shortly before the CD matures requesting directions. The notice usually offers the choice of withdrawing the principal and accumulated interest or rolling it over (depositing it into a new CD). Generally, a window is allowed after maturity where the CD holder can cash in the CD without penalty. In the absence of such directions, it is common for the institution to roll over the CD automatically, once again tying up the money for a period of time (though the CD holder may be able to specify at the time the CD is opened not to roll over the CD). 3. CD refinance In the U.S. insured CDs are required by the Truth in Savings Regulation DD to state at the time of account opening the penalty for early withdrawal. These penalties cannot be revised by the depository prior to maturity. The penalty for early withdrawal is the deterrent to allowing depositors to take advantage of subsequent enhanced investment opportunities during the term of the CD. In rising interest rate environments the penalty may be insufficient to discourage depositors from redeeming their deposit and reinvesting the proceeds after paying the applicable early withdrawal penalty. The added interest from the new higher yielding CD may more than offset the cost of the early withdrawal penalty. 4. Deposit insurance In the US, the amount of insurance coverage varies depending on how accounts for an individual or family are structured at the institution. The level of insurance is governed by complex FDIC and NCUA rules, available in FDIC and NCUA booklets or online. The standard insurance coverage is currently $250,000 per owner or depositor for single accounts or $250,000 per co-owner for joint accounts until December 31, 2013. On January 1, 2014, the standard coverage limit will return to $100,000 per depositor for all accounts except for certain retirement accounts, which will remain at $250,000 per depositor. Some institutions use a private insurance company instead of, or in addition to, the Federally backed FDIC or NCUA deposit insurance. Institutions often stop using private supplemental insurance when they find that few customers have a high enough balance level to justify the additional cost. Impact The CDs combine features of equity and debt. The terms of the CDs differ from those of conventional bank deposits in that, while we may pay a Coupon Payment, we will not pay regular periodic interest on the CDs and a significant portion of your total payment at maturity may be based on the performance of the Index. If the Ending Index Level does not exceed, or in certain cases, equal, the Starting Index Level at maturity you will receive (in addition to a Coupon Payment, if applicable) only $1,000 (plus the Minimum Return, if any) for each $1,000 CD, unless otherwise specified in the relevant term sheet. Therefore, the return on your investment in the CDs may be less than the amount that would be paid on an ordinary bank deposit. The return at maturity of only the principal amount of each CD (plus the Minimum Return, if any) will not compensate you for any loss in value due to inflation and other factors relating to the value of money over time. When the financial crisis is comi ng. The CDS will have a lot of problems. Such as credit risk. For exam if Your investment in the CDs will involve certain risks. The CDs may not pay interest or guarantee any return of principal prior to maturity unless otherwise specified in the relevant term sheet. Investing in the CDs is not equivalent to investing directly in the Index or any of the component currencies of the Index. In addition, your investment in the CDs entails other risks not associated with an investment in conventional bank deposits. You should consider carefully the following discussion of risks bef ore you decide that an investment in the CDs is suitable for you. The impact of financial crisis on bankers acceptence What is the bankers acceptence? A bankers acceptance, or BA, is a negotiable instrument or time draft drawn on and accepted by a bank. Before acceptance, the draft is not an obligation of the bank; it is merely an order by the drawer to the bank to pay a specified sum of money on a specified date to a named person or to the bearer of the draft. Upon acceptance, which occurs when an authorized bank accepts and signs it, the draft becomes a primary and unconditional liability of the bank. If the bank is well known and enjoys a good reputation, the accepted draft may be readily sold in an active market. A bankers acceptance is also a money market instrument a short-term discount instrument that usually arises in the course of international trade. A bankers acceptance starts as an order to a bank by a banks customer to pay a sum of money at a future date, typically within six months. At this stage, it is like a postdated check. When the bank endorses the order for payment as accepted, it assumes responsibility fo r ultimate payment to the holder of the acceptance. At this point, the acceptance may be traded in secondary markets much like any other claim on the bank. Bankers acceptances are considered very safe assets, as they allow traders to substitute the banks credit standing for their own. They are used widely in international trade where the creditworthiness of one trader is unknown to the trading partner. Acceptances sell at a discount from face value of the payment order, just as US Treasury bills are issued and trade at a discount from par value. Bankers acceptances trade at a spread over T-bills. The rates at which they trade are called bankers acceptance rates. The Fed publishes BA rates in its weekly H.15 bulletin. Those rates are a standard index used as an underlier in various interest rate swaps and other derivatives. Acceptances arise most often in connection with international trade. For example, an American importer may request acceptance financing from its bank when, as is frequently the case in international trade, it does not have a close relationship with and cannot obtain financing from the exporter it is dealing with. Once the importer and bank have completed an acceptance agreement, in which the bank agrees to accept drafts for the importer and the importer agrees to repay any drafts the bank accepts, the importer draws a time draft on the bank. The bank accepts the draft and discounts it; that is, it gives the importer cash for the draft but gives it an amount less than the face value of the draft. The importer uses the proceeds to pay the exporter. Impact By financial crisis is coming. There is a lot of impacts on money market. Such as the impact of financial crisis on bankers acceptence. Bankers acceptance means that if you invest or save the money into the bank, maybe after the 3 years you wanna to withdraw your investment. Before that you have the contract between you and the bank. But nowadays the financial crisis is broke out, so the bank can not give the interest to you or bank will decrease the interest rate that will course the credit crisis, because of the financial crisis. At that time the bank also sell a lot of coupon bond, due to the financial crisis. The buyer can not afford the value of bond to the bank therefore course the credit crisis which the bank can not fulfill their promise to the customer. Massive reduction and liquid problems of credit raiting in banks (for the first time in (Northern Rock) in April and May 2007 and since 2005, the range of problems such as the results of slump in real estate, influence on d evaluation bank assets and manifestation of bankruptive effect on a number of banks have reached crisis point by September 2008. Financial sector was considerably damaged by unprecedented growth of prices that significantly declined after eliciting financial crisis and credit restriction. In the structure of consumption, forced high cost made a negative influence on the broad masses of populations savings and accordingly on the size of investments, also it caused the rise of cost price. therefore, demands decreased because of two factors. (second one wich was partially formed by the influence of the first one is connected to the reduction of corporations winning and the slump on their bonds). In 2007 for the purpose of reduction in the price of oil, concrete non-co-ordination experiment by the central banks of separate countries, in the usage of money credit regulation in currency rates, considering taxation balance sheet. On the background of multidimensional, different priorities and difficulties, the problems were mostly revealed in the difference of interest rates. The rise in oil price, must have firstly been reflected in the USA $ purchasing capacity, but in a number of countries, all over the world, oil import (reflected on money) when in deals, it is invested in USA $, it raised the demands on USA $ currency and conditioned the devaluation on Japanese yen, euro and pound sterling. For the beginning of reduction in oil price, financial crisis had already been from the USA, withal president election in the USA created an atmosphere for the better future changing. Currently, the countries all over the world, cut main interest rates and accordingly the difference among them is decreasing. It can be explained by the following conditiones: mortgage credits were provided with the flats on sale and accordingly their market price defines the existence of possible losses or their size of credits in the case of default by debtors, until the term expires or bef ore default, suitable credit letter or security, steadied by it, as the cost of assets. Creditors interest, connected with the price growth of real estate is against the debtor and that is the most essential during the period of mortgage, price growing in funds flow increases the share of expenses: Debtors funds flow is the most important component of its solvency. Undisturbed up growth of price on real estate, accordingly a great number of debtors and reinforcement of competition among credit organizations: motivation of cutting down the expenses of debtors credit analysis by banks, conditioned mortgaging credit insurance to be accented and in fact, this priority made debtors credit analysis into a minor importance question. Though it must be the first and uppermost source of covering the loans and according to the request of prudential law, mortgage as a means of covering loans must be used only in the extreme situations. Yet, this request is followed by banks, still, the importan t is not only loan repayment by debtors, instead of the results of credit analysis (especially, according to the corresponding funds-flow) but dependence on insurance while taking decision about credit, means that the possibilities of default indices are quite high. Rising by 2-3% in the real sector of economy, in the conditions of property differentiation growth, for the part of such outnumbered debtors credit covering has turned out impossible. The flats, had been moved in the property of banks, still returned back to the real estate markets. Because of increased deliveries and frequent defaults, the limit on distribution the mortgage credits, caused disastrous slump in real estate property prices. On its side it ment the decline in the maintenance of mortgage credits. Tendency of slump and deterioration of assets quality, that also conditioned the aggravation of liquidity problem, (during this period, reduction of credit rating, quite scared the investors and hedge funds) made th e banks minimize the new credit delivering process. Real estate delivery, was mostly realized by using the mortgage credits and without this, the recession of building sector has not been delayed. Conclusions on credit markets.