Terms Beginning With 'c'

Certificate of Deposit

What is meant by a Certificate of Deposit?

A certificate of deposit is a savings account in which a predetermined amount of money is deposited in a fixed account for a specific amount of time, offering an interest rate higher than other savings account. Certificates od deposit or CDs, are issued to increase the range of money market instruments giving investors greater flexibility in terms of short-term funds utilization.

CDs are issued by commercial banks and act as an agreement between the depositor and the bank. The deposit by the customer must be a lump sum amount and should be left untouched for the specified period.

The rates offered on CDs may differ from bank to bank. Besides, the term for which the account is issued may also vary with each bank. If the deposit is withdrawn before the specified amount of time, then the depositor may be subjected to a fee.

How does a certificate of deposit work?

The depositor must deposit a lump sum amount of money while opening a CD account. The issuer of the CD, in return, offers interest payments at regular intervals till the date of maturity. At maturity, the account holder receives the entire amounted that was initially invested, in addition to all the interest.

Investors may find it profitable to opt for CDs that have a longer term rather than those with a shorter term as the former usually have a higher yield. Additionally, CDs have a higher interest rate associated with them compared to other savings accounts to compensate for the funds not being as liquid as other savings deposits.

Certain banks may offer a variable interest rate while others may prefer to hold onto the stock market related indices as an index for the CD. Moreover, not all banks may charge a fee in case of early withdrawal as they allow the owner to withdraw out of the interest earned till that period.

In certain instances, CDs may automatically roll over post the maturity date. Whereas, in many other cases, CDs stop accumulating interest post the maturity.

What are the different features of a CD?

Following are the features of a CD that make it a unique security instrument:

  • Low risk: CDs are deemed as low-risk investments as they offer a steady income without much volatility. These are good investment options for those who want to save money for retirement.
  • Lower liquidity: When compared to bonds and other types of investment vehicles, CDs are not as liquid and are hard to convert to cash.
  • Interest rate: The longer a CD account is maintained, the higher interest it would accumulate. Thus, the prize for keeping one’s money locked up in a CD is higher interest. When interest rates are rising overall, it is a good idea to invest in a CD account.

 

However, it might not be beneficial to lock up money in a long-term CD when interest rates are rising too quickly as the depositor may be locked into one rate, missing out in the increasing rate. As a solution to this, investors set up “CD ladders” wherein money is placed in different CDs having differing maturities. Thus, it allows them to always have liquid funds, even with money locked up in CDs.

What types of CDs are there?

CDs can be of various types, some of these include:

  1. Traditional CD: A traditional CD involves depositing a fixed amount of money for a predetermined amount of time, against a fixed interest rate. These CDs do not have any additional provisions and can only be withdrawn at the end of the maturity period. Early withdrawals come with a huge penalty, which can be as high as the initial principal amount.
  2. Step-up CD: A step-up CD can be used to move towards a higher yield, automatically. These are lesser-known CDs as there is no guarantee that the new yield would fetch higher Annual Percentage Yield (or APY) than a traditional CD.
  3. Bump-up CD: Just like a step-up CD, a bump-up CD is also used when the depositor wants to move to a higher yield. However, here the difference is that the bump-up is not automatic. Here the depositor must seek permission from the bank to move to a higher yield. In this case too, investors might be met with a lower APY than that earned on a traditional CD.
  4. Liquid CD/ No-penalty CD: These offer the feature of early withdrawal of funds without the depositor having to pay a fee. The APY associated with a liquid CD can be higher than that offered on other savings accounts however, not as high as that of a traditional CD. A liquid CD may have varying periods until which the deposit must be held with the bank. However, most banks may require the deposit to stay intact for at least a week’s time.
  5. Zero-Coupon CD: These CDs do not have any coupon payments attached to them. However, the only returns offered on these types of CDs is the face value paid back at maturity along with the accrued interest.
  6. Callable CD: These CDs offer higher interest; however, they have a risk attached to them. In the event when rates might fall, the issuer can call back the bond and issue it at the new rate, which is lower than the original agreed upon rate. Thus, a higher yield comes at the cost of future uncertainty regarding the rates.

Which institutions can issue a CD?

Almost every bank may be able to offer at least one CD, even those institutions that do not have a brick-and-mortar presence may be authorized to issue a CD. Thus, any institution that accepts customers through online platforms may be eligible to issue a CD.

It is advisable to explore different types of CDs that are available before taking the decision to invest in one.

What is an Absolute Advantage? Absolute advantage is one of the key macroeconomic terms, which is based on the principles of Capitalism and is often utilised in international trade-related decisions. Absolute advantage refers to the competence of a company, region or country to produce goods or services in an efficient manner compared to any other economic entity. The efficiency in production can be achieved by: Production of the same quantity of good or services as produced by other entity by utilising fewer amount of resources Production of a higher quantity of good or services as produced by other entity by using the same amount of resources What is the Significance of Absolute Advantage? Different countries or businesses possess a different set of ability owing to their location, soil composition, weather, infrastructure, or human resource skills. When applied in the right direction, various factors may pan out to offer more cost-effectiveness and hence build absolute advantage of the entity in comparison to others.  The absolute advantage remains one of the critical determinants for the choice of the goods or services to be produced. Absolute advantage in a particular area often translates into profitability in the area. The profit margin increases by the achievement of cost efficiency, allowing the entity to ensure higher profitability over the competitors.  For example, let us assume that the US can produce ten high-quality aircrafts utilising a specific amount of resources. China, on the other hand, can build 6 similar quality aircrafts using the same amount of resources. Thus, in the production of an aircraft, the US holds Absolute Advantage Let’s say the US has the ability to manufacture a certain amount of steel using 10 tonnes of iron ore. China, on the other hand, can produce the same quantity of steel using 8 tonnes of iron ore.Here, China here holds Absolute Advantage in the production of steel.  How Countries Build Absolute Advantage? While natural conditions, which include climatic factors, geometry, topography, cannot be altered for achieving absolute advantage, the countries use the underlying factors strategically in their favour. Furthermore, factors of production are focused at by many companies or nations for building absolute advantages.  Some of the strategies for building absolute advantage includes: Development of Technological Competencies- The implementation of innovative or latest technological innovations allows the entities to lower their production cost, facilitating absolute advantage.  Enhancing Skills of Human Resources- The improvement in the cost-efficiency, along with the quality of the products, is targeted through imparting varying skill development programs. Many countries subsidize or aid the apprentice or labour training for enhancing the absolute advantage in trade.  Improving Infrastructure- The infrastructure enhancement in the form of road, telecommunications, ports, etc. can be useful in enhancing the cost-effectiveness across different industries.  What Do We Understand by Comparative Advantage Vs Absolute Advantage? Evaluating the comparative advantage introduces the concept of opportunity cost, which is the deciding factor to determine the production of particular goods or services. Opportunity cost refers to the potential benefits associated with the next best possible alternative which is missed out when one option is chosen over another.  The Absolute advantage simply considers the capability of a business or region to deliver goods or services in the most efficient manner. The Comparative Advantage, however, also takes into account the benefits that are forgone if an entity decides for production of a particular product or services.  Comparative advantage, based on the notion of mutual benefits, is often used in international trade deals. The Comparative advantage has been the major factor driving the outsourcing of services in search of cheap labour.  Understanding through an Example For instance, country A can produce ten televisions with the same amount of resources with which it can make 7 laptops. The opportunity cost per television is 7/10 or 0.7 laptops. Meanwhile, the opportunity cost per laptop is 10/7 or 1.42 television.  It highlights that country A is forsaking the production of 0.7 laptops if it is deciding to manufacture one television. On the other hand, it is missing out the opportunity to manufacture 1.42 televisions for every single laptop manufactured.  Now, say Country B’s opportunity cost for producing a television is 0.5 laptop, and that of producing laptop is 2 televisions. Then, country B will have a comparative advantage in making televisions, and country A will have comparative advantage in producing laptops. It has to be noted that despite country A having absolute advantages in both the products, it would be mutually beneficial for both the countries if country B produces television while country A produces laptops. Do You Know About Absolute Advantage Theory by Adam Smith? The concept of Absolute Advantage was indicated by Adam Smith in his book called ‘Wealth of Nations’ which focusses on International trade theory. Adam Smith, in his book attacked on the previous mercantilism theory, which mainly stressed for economies to maintain trade surplus in order to command power.  The Absolute Advantage theory considered that the countries possess different ability with respect to the production of varying goods or services. It argued that it is not necessary that a state may hold an absolute advantage in the production of all goods, and here the relevance of trade comes into play.  It advocates that countries should produce those goods over which they hold a competitive advantage. It would allow the countries to make the same amount of goods using few resources or in less time. The theory propagates the relevance of trade for economic sustainability.  What Are the Limitations of the Absolute Advantage Theory? The assumptions used in the Absolute Advantage Theory by Adam Smith may limit the application in real bilateral trade. The limitations of the theory by Adam Smith include: Smith assumed that the productive capabilities of a country could not be transferred between the two countries. However, in practical terms, the competitive scenario aids the nations to acquire new capabilities and acquire new resources, especially in the technological and human resource skill aspects.  The two-country trade which was used as a basis for the theory does not consider the trade barriers levied. The present scenario, however, is strikingly dominated by trade wars between economies. Nations impose huge tariffs, import duties and other type of barriers to promote local manufacturers.  Absolute Advantage theory assumes that the trade between the two nations will take place only if each of the two economies holds an absolute advantage in one of the commodities traded. However, in general, countries despite not holding absolute advantage are engrossed in international trade, boosting their economic setup.

Difference between actual and an expected return. For example, if a stock increased by 7% because of some update, but the average market only increased by 3% and the stock has a beta of 1, then the abnormal return was 4% (7% - 3% = 4%)

Gain or loss as a percentage of the initial capital invested. For example – If we gain $10 on investing $100, our Absolute return would be 10% ($10/$100*100)

Calculating the cost of a product or an enterprise based on the direct and the indirect costs (overheads) involved. Multiple methods of absorption costing include Direct labour cost percentage rate, Direct material cost percentage rate, Labour hour rate , Prime cost percentage rate and Machine hour rate.    

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