Certificate of Deposit UPSC – Features, and Limitations of CD

Certificate of Deposit

The Certificate of Deposit (CD) is a money market instrument that is not secured by any collateral and is negotiable. It can be compared to a promissory note as it guarantees a fixed return to the holder. The Reserve Bank of India regulates the issuance of this fixed-income financial instrument, which is electronically issued and held in a dematerialized form. Such a financial instrument is guaranteed to pay out a specific amount at the outset, thereby assuring investors of a predetermined payout.

Any financial institution in India or scheduled commercial bank is eligible to issue a Certificate of Deposit, which is valued at a discount from its face value. The Certificate of Deposit operates similarly to a fixed deposit account by providing written evidence that the investor has deposited funds with the bank for a specified period, with interest being calculated based on the amount and duration of the deposit.

Features of Certificate of Deposit

A Certificate of Deposit (CD) is a financial instrument that has several distinct features that make it unique. The Certificate of Deposit is a conservative investment option that provides investors with a fixed return and a sense of security. It is particularly attractive to risk-averse investors who are looking for a safe and reliable investment option. Some of the key features of a Certificate of Deposit include:

• Fixed term: The Certificate of Deposit is a time deposit, meaning it has a fixed term, which ranges from a few weeks to several years. The investor cannot withdraw the funds before the term ends without incurring a penalty.
• Fixed interest rate: The Certificate of Deposit offers a fixed interest rate, which is determined at the time of issuance and remains constant for the term of the deposit. The interest rate may be higher than a regular savings account or a checking account.
• Guaranteed return: The Certificate of Deposit offers a guaranteed return, as the bank or financial institution promises to pay a specific amount at the end of the term. This provides investors with a sense of security and predictability.
• Non-negotiable: The Certificate of Deposit is a non-negotiable instrument, meaning it cannot be transferred to another party. The investor must hold the Certificate of Deposit until maturity to receive the promised return.
• Dematerialized form: The Certificate of Deposit is issued and held in a dematerialized form, which means it is electronically recorded and traded. This reduces the risk of loss or theft and makes it easier to trade.
• Minimum investment: The Certificate of Deposit typically requires a minimum investment amount, which can range from a few thousand rupees to lakhs or crores, depending on the bank or financial institution.

Limitation of Certificate of Deposit

While a Certificate of Deposit (CD) has several benefits, there are also some limitations that investors should be aware of. The limitations of a Certificate of Deposit may make it less attractive to some investors, particularly those who are seeking higher returns or greater flexibility. Some of the key limitations of a Certificate of Deposit include:

• Fixed term: The fixed term of the Certificate of Deposit means that the investor cannot access the funds before maturity without incurring a penalty. This lack of liquidity can be a significant limitation for some investors who may need access to their funds for unexpected expenses or emergencies.
• Inflation risk: The fixed return on a Certificate of Deposit means that the investor is exposed to inflation risk. If inflation rises during the term of the Certificate of Deposit, the purchasing power of the return will decrease.
• Limited return: The return on a Certificate of Deposit is typically lower than other investment options, such as stocks or mutual funds. This limited return can be a limitation for investors who are seeking higher returns.
• Non-transferable: The Certificate of Deposit is a non-transferable instrument, meaning that the investor cannot transfer it to another party. This lack of liquidity can be a limitation if the investor needs to sell the Certificate of Deposit before maturity.
• Penalty fees: If the investor needs to withdraw their funds before maturity, they will likely incur a penalty fee, which can reduce their return or even result in a loss.
• Minimum investment: The minimum investment required for a Certificate of Deposit can be a barrier for some investors, particularly those with limited funds.
• Lack of diversification: Investing in a Certificate of Deposit can be less diversified than investing in other financial instruments, such as stocks, bonds, or mutual funds. This lack of diversification can increase risk and reduce potential returns.

Difference Between a Certificate of Deposit and a Fixed Deposit

Certificates of Deposit and Fixed Deposits are two common investment options that provide a fixed rate of return for a specific period. These investment instruments are offered by banks and financial institutions to provide a secure and stable source of income to investors.

• Indian National Congress
• French Revolution
• Prehistoric Period

While both Certificates of Deposit and Fixed Deposits offer a guaranteed return and a fixed term, there are some key differences between the two that investors should consider before making a choice. In the table below check the differences between a Certificate of Deposit and a Fixed Deposit:

Certificate of Deposit	Fixed Deposit
Certificates of Deposit are a money market instrument	Fixed Deposit is a term deposit
Certificates of Deposit are negotiable, unsecured, and issued in a dematerialized form	Fixed Deposit is non-negotiable, secured, and can be issued in physical or electronic form
Certificates of Deposit have a higher minimum investment requirement	Fixed Deposit can be opened with a lower minimum investment
Certificates of Deposit offer a fixed interest rate for a specific term	Fixed Deposit offer a fixed or variable interest rate for a specific term
Certificates of Deposit are non-withdrawable before maturity without incurring a penalty	Fixed Deposit may allow partial withdrawals before maturity with a penalty or without any penalty in some cases
Certificates of Deposit typically have a shorter term than FDs	Fixed Deposits can have varying terms ranging from a few months to several years
Certificates of Deposit are not insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC)	Fixed Deposit are insured by the DICGC up to Rs. 5 lakhs per depositor per bank

Certificate of Deposit UPSC

Certificate of Deposit is an important topic for the UPSC Civil Services Examination, especially for the General Studies 3 of the Mains Examination, which deals with the Indian economy and related topics. The concept of a Certificate of Deposit is relevant for understanding the functioning of the money market and the role of financial institutions in mobilizing savings and providing investment options to individuals and businesses.

Candidates who are preparing for the Civil Services Exam should keep themselves updated with the latest developments in the field of finance and economics and should be familiar with various investment instruments, including Certificates of Deposit.

Certificate of Deposit UPSC Question

Question 1: Explain the concept of a Certificate of Deposit and its significance in the Indian money market.

Question 2: Discuss the role of financial institutions in issuing Certificates of Deposit and their impact on the Indian financial sector.

UPSC Notes
Federalism	Cabinet Ministers
Schedules of Indian Constitution	Freedom Fighters of India
Ramsar Sites	Rivers of India
Articles in Constitution India	Dances of India
Writs	Salient Features of Indian Constitution
Civil Disobedience Movement	Dams in India
Viceroy of India	DPSP