What is a Callable CD?
A callable CD is a certificate of deposit that can be called by the issuer at some point before the CD reaches full maturity. While the investor is assuming a higher degree of risk with this type of CD, the potential return is much higher than with a standard certificate of deposit. This possibility of earning more over the life of the financial instrument has made the callable CD a viable investment option for many people.
With a standard CD, the investor deposits a specific amount of money, leaving those funds in place until the CD matures. At that point, the investor can withdraw the interest and roll the principal of the CD over into a new certificate of deposit, effectively creating an ongoing profit off the same initial investment. While a callable CD provides these same benefits, the devices offer a higher return, if the issuer chooses to leave the CD in place all the way to maturity.
Essentially, the callable CD allows issuers to shift the risk that interest rates will change significantly over the life of the CD to the investor. The provisions on this type of certificate of deposit only guarantee that the issuer will leave the CD in place for a minimum period of time. For example, the issuer may include a provision that makes it possible to call the CD after six months, rather than allowing it to remain in place for an entire eighteen months to two years. Should interest rates decrease, there is a good chance that the issuer would call the CD after six months, effectively allowing the issuer to benefit from the arrangement.
For the investor, a callable CD may be a good option, if certain circumstances exist. First, if the current economic environment indicates that the interest rate will remain stable for at least the guaranteed call-protection period associated with the instrument, the investor can rest assured of at least earning that amount of return. The longer that the issuer chooses to leave the CD in place, the higher the earnings for the investor. By considering the earnings from this perspective rather than the amount that would be earned if the CD is left in place until maturity, it is easier to decide if this investment is a better or worse option than going with a standard CD with a fixed rate of interest.
It is important to remember that just because the issuer can call a callable CD before full maturity, there is no guarantee that an early call will actually take place. Unless interest rates decrease and make it in the best interests of the issuer to call the CD, there is a good chance the instrument will be allowed to reach maturity. When this is the case, the investor will earn a higher return that would have been possible with a standard CD carrying the same duration to maturity.
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