Certificates of Deposit (CD's)

System
System Posts: 100,534 🤖 Admin 🤖
edited June 18 in AAT student discussion
Hi Everybody,
Silly question I know - but am I right in assuming that interest is paid on CD'S? If so, when? Going by todays interest rates if I were to invest the minimum £50,000 what would my return be? :(

Comments

  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    AS far as I know CD's are more or less bonds issued mostly by banks.

    Also they can have a fixed or variable rate of interest so of course only variable rate CD's would be affected by intrest rates.

    To work out what an investment is worth it depends on how many years it is for, what the cashflows in from interest is, and if you wanted a true value you would need to use discount factors on the cash inflows and capital amount when you receive it back.


  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    CD's are similar to bonds in the respect that you would invest for £x amount per year and get a guarateed yield back. For example the bank has agreed to pay 5.00% per annum on £10m for 5 years. Your annual interest earned would be £10,000,000.00x5.%=£500,000.00, if the starting period is less than 365 days then it would be £10,000,000x 5%/365* no of days. This would be paid annually from the start date of the CD. CD's are more long term invested whereas CP's (Commercial papers tend to be less than 1 year)
  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    Thanks to you both for your help...much appreciated!
  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    Very often a certificate of deposit will have a value of say £50,000 on say 1st July 2006
    If you bought it on 1st July 2005 you would buy it at a discount.
    If the interest was 10% then the price you would pay for a certificate guarenteeing you £50,000 in one years time would be £50,000/1+10%

    Which I think is £45,450 to the nearest £10

    Thus your 10% is 10% of the amount you invested.

    A CoD has a market value and can be sold by whoever bought it. Rather like pass the parcel, who ever has it on the redemption date can take it to the bank for the cash (£50,000)

    Many years ago a lot of CoDs were stolen, but as they are not traceable the person whole had them stolen was not able to recover them.
  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    Just to clarify (and be a bit more swotty about it) when you say "if the interest was 10%" what we are referring to is the cost of capital.

    The cost of capital is what is required to invest in something.

    For instance, if the bank is paying a rate of interest of 5% and the certificate of deposit is going to return you 5% or less you will not invest in it. Anything above 5% and we start to get into the realms of investment risk. If the investment has little risk perhaps 6% might be satisfactory. If the risk is higher then perhaps 10% would be required, or in other words the cost of supplying that capital would be 10%.


    If the certificate of deposit (or any other type of investment) is spread over several years than the 10% cost of capital needs to be considered for each year, or as we all know as discount factors and NPV (nett present value)as Sandy has demonstrated.

    Sorry ill shut up now I think im getting carried away I think ive been studying to hard lately!
  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    Lincs

    You are quite right to look at the NPV aspect, but bear in mind that CoDs are low risk and as such can be compared directly with bank deposits.
    That is as far as CMCC is likely to take it. If as I suspect you are studying for a higher qualification, you might mention tranaction charges, but even ACCA and CIMA do not go into detail on these in their exams.

    Sandy
  • System
    System Posts: 100,534 🤖 Admin 🤖
    Re:Certificates of Deposit (CD's)

    Individuals, Partnerships, Personal Representatives, Trustees or Companies may purchase certificates of tax deposits, subject to an initial deposit of £2,000, with minimum additions of £500. The certificates may be used to pay any tax except PAYE, VAT, tax deducted from payments to subcontractors and corporation tax. The only purpose for which companies can use tax deposit certificates is to pay income tax due under quarterly accounting system. The reason being that any interest due on corporation tax is now chargeable under loan relationships rule and so any interest charged and any interest received is netted off. For income Tax the rules have changed in the FA 2005 but I don’t have my Yellow Handbook to check it out. They are basically in line with Corporation Tax.

    Interest is at a variable rate on a daily basis for a maximum of 6 years. You get lower rates of interest if you cash them rather than use them to cover your tax liabilities. This interest is taxable under schedule D case III.

    The certificates are way to ensure that funds are available to meet tax payments when due and to prevent interest charges on tax that is in dispute, because interest on overdue tax is not charged when the certificates are used to pay tax, unless the deposit was made after the normal due date.

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