market linked cd

CD Products: Market-Linked CD


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24 April,2013

For those looking for yield, CDs don’t often come to mind. While your money is usually safe in CDs, you won’t earn a high yield.

One way to earn a higher yield, though, is to consider a market-linked CD.

What is a Market-Linked CD?

A market-linked CD is pretty much what it sounds like: The return on the CD is influenced by securities. A market-linked CD can be linked to a single equity, or to an index. As the equities involved do well, the CD offers a higher rate of return. When the market falters, though, you run the risk of a lower return.

A market-linked CD’s return is based either on the difference between the start point and the end point, giving you a return equal to any increase, or by taking an average of the equities’ performance at different milestones during the maturity of the CD.

In most cases, a market-linked CD will guarantee your principal, and possibly a small rate of return, in line with most other CDs. However, the fact that the CD is linked to a higher-yielding investment product means that there is the chance of better returns over time.

It’s important to understand, though, that there are some limits to what even a market-linked CD will earn. Some of the limits are brought on by:

  • Interest cap: Many banks and credit unions put an interest cap on their market-linked CDs in order to keep from having to pay too high a yield.

  • Participation rate: There might also be a participation rate associated with your market-linked CD. A market-linked CD might have a participation rate of 75%, meaning only 75% of the market return is factored in. If the market returns 10%, this means that you will only see a return of 7.5%.

Realize, too, that if there is an interest cap, it will limit what you can earn — even if your participation rate would normally allow you to see higher gains.

Things to Keep in Mind with a Market-Linked CD

A market-linked CD operates like other CDs. You have a set term, and if you take your money out before your CD matures, you will be charged penalties.

Additionally, be aware that some banks and credit unions issue CDs with call features. This feature lets the issuer recall the CD prior to the term being up. The CD is redeemed at the call price, which limits how much you might earn in a given period. Some CDs like this have a call period, which means that once the call period is up, the bank or credit union can’t redeem it early.

If you have a five-year CD with a call period of two years, that means that the issuer can redeem it at any time within that two-year period. If a bank feels that the market is going to keep rising, it might call in the CD, and then you would have to get a new CD with a different participation rate, or with some other alteration in terms.

Before deciding if a market-linked CD is right for you, do a little research, and consult with an investment professional who can help you understand the pros and cons.