I was just perusing E*Trade Bank and looking at their CD rates. They offer:
3 Month - 6.40%
6 Month - 6.50%
1 Year - 6.60%
15 Months - 6.60%
1.5 Years -6.60%
2 Years - 6.15%
2.5 Years - 6.18%
3 Years - 6.20%
5 years - 6.25%
Now this seems odd to me. As far as I understand it, CDs are essentially the same as a money market account except you’re forbidden from withdrawing the mulah until the specified time is up, thus the bank can make higher return investments with your money, thus the higher interest rate. So why are the middle ones the highest? Shouldn’t the five year CD have the hghest return? And what’s the point of opening a 2 year CD at 6.15%, when I can open a 1.5 year one for 6.60%?!
CDs are tradeable instruments, which means that their price doesn’t just reflect where rates are now, but also future expectations of interest rates and reinvestment risk.
In the current tightening environment, rates will be dropping which means that if you re-invest the interest from your CD in a tightening environment, you’ll be re-investing it at a lower rate of interest than is currently available in the maket, and so your ultimate yield will be lower, reflected in lower interest rates paid on your CD.
Damn, this one instance where my expertise finally comes in handy, and Moonshine beats me to it!
Excellent explanation, though.
The hyperbole (or sometimes parabole) figure that the (expected) interest rate describes over time is known as the Yield Curve. In this case, long term interest rates are lower than short term ones, reflected in the pricing of the Certificates of Deposits (to explain the abbreviation for those not in the know) with a longer time-to-maturity.