Understanding Certificate of Deposit (CD) Investments and Calculations in Excel

A certificate of deposit (CD) is a type of savings account that offers a fixed interest rate and a fixed maturity date. When you open a CD, you agree to deposit a certain amount of money for a certain period of time, such as six months, one year, or five years. In return, the bank pays you a higher interest rate than a regular savings account. You cannot withdraw your money from the CD before the maturity date without paying a penalty fee. CDs are considered low-risk investments because they are insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) up to $250,000 per depositor, per institution.

CDs have different features and benefits depending on the bank, the term, and the amount of money you deposit. Some common types of CDs are:

• Fixed-rate CD: This is the most common type of CD, where the interest rate stays the same for the entire term of the CD.
• Variable-rate CD: This is a CD where the interest rate can change during the term of the CD, based on an index such as the prime rate.
• Jumbo CD: This is a CD that requires a large minimum deposit, usually $100,000 or more, and offers a higher interest rate than a regular CD.
• Add-on CD: This is a CD that allows you to make additional deposits to the CD after the initial deposit, usually with a minimum amount and frequency.
• CD ladder: This is a strategy where you open multiple CDs with different terms and maturity dates, so that you can take advantage of higher interest rates and have access to your money at regular intervals².
• Liquid CD: This is a CD that allows you to withdraw a portion of your money from the CD without paying a penalty fee, usually with some restrictions and conditions.

CDs are a good option for saving money that you do not need in the short term, and that you want to earn a higher interest rate than a regular savings account. However, CDs also have some drawbacks, such as:

• Lack of liquidity: You cannot access your money from the CD until the maturity date, unless you pay a penalty fee, which can reduce your earnings.
• Interest rate risk: If the market interest rates rise after you open a CD, you will be locked in a lower rate for the term of the CD, and you will miss out on the opportunity to earn more interest elsewhere¹.
• Inflation risk: If the inflation rate rises above the interest rate of your CD, you will lose purchasing power over time, as your money will be worth less in the future.

Therefore, before you open a CD, you should compare the interest rates, terms, features, and benefits of different CDs from different banks, and choose the one that best suits your financial goals and needs.

Basic Theory:

A Certificate of Deposit is a time deposit offered by banks or financial institutions. Investors deposit a certain amount of money for a fixed period, known as the term, and in return, they receive a fixed interest rate. CDs are considered low-risk investments due to their fixed interest and guaranteed return of principal at maturity.

Procedures:

1. Determine Investment Amount: Decide on the amount you want to invest in the CD.
2. Select the Term: Choose the term of the CD, which can range from a few months to several years.
3. Check Interest Rate: Confirm the interest rate offered by the bank for the chosen term.
4. Calculate Interest Earned: Use the formula for simple interest to calculate the interest earned over the investment period.
   
   Interest = Principal × Rate × Time
   
   Where:
   • Principal is the initial investment amount.
   • Rate is the annual interest rate.
   • Time is the investment period in years.
5. Determine Maturity Value: Add the interest earned to the principal to get the total amount at maturity.

Comprehensive Explanation with Scenario:

Let’s consider a scenario:

• Initial investment (Principal): $10,000
• Annual interest rate: 3.5%
• Term: 2 years

Excel Calculation:

Set up an Excel table with the following columns: Principal, Rate, Time, Interest, Maturity Value.

Use the following Excel formulas:

• For Interest: =Principal * Rate * Time
• For Maturity Value: =Principal + Interest

Apply the formulas to get the results in the respective columns.

Result:

At the end of the 2-year term, the investment of $10,000 in the CD will mature to $10,700.

Other Approaches:

1. Compound Interest:

   If the CD compounds interest, use the compound interest formula for more accurate calculations:

   A = P (1 + r/n)^(nt)
   
   Where:

   • A is the amount at maturity.
   • P is the principal.
   • r is the annual interest rate.
   • n is the number of times interest is compounded per year.
   • t is the number of years.
2. Excel Functions:

   Explore Excel functions like FV (Future Value) for compound interest calculations and PV (Present Value) for calculating the initial investment required for a desired future value.