callable CD

callable CD

A certificate of deposit that can be redeemed prior to the scheduled maturity. Many retail brokerage firms broker callable CDs issued by insured financial institutions. These CDs, often with long maturities, are traded in the secondary market and can fluctuate in value with changes in market rates of interest. Also called deposit note.

Case Study Although insured, callable certificates of deposit can spell trouble for unwary investors. The issuer can redeem a callable certificate of deposit prior to the scheduled maturity, but an investor holding the CD cannot redeem it prior to the scheduled maturity. The investor can only liquidate the CD through a sale in the secondary market, possibly for less than the principal or the investor's purchase price. Heads the issuer wins, tails the investor loses. The investor gains little if market interest rates fall, because the CD is likely to be redeemed early by the issuer. On the other hand, there is much to lose if market interest rates rise and the CD must be held for a long period of time. The added risk of the call feature causes issuers to pay higher interest rates on callable CDs than are paid on regular certificates of deposit. In late 2000 the New York Stock Exchange censured and fined a major brokerage firm for failing to supervise and control the sale of approximately $3 billion in callable CDs to approximately 161,000 customers. Some of the customers claimed their brokers did not inform them issuers could redeem the CDs prior to scheduled maturity. Other investors complained brokers did not warn that the CDs could not be cashed in early. The danger in owning these investments is particularly great for callable CDs with long maturities. Unlike regular certificates of deposit, which typically have maturities of six months to 5 years, callable CDs sometimes have maturities of 20 to 30 years.