A:

There is a fair amount of overlap between certificates of deposit (CDs) and bonds; they are both fixed-income securities, which you generally hold on to until maturity. Simply put, you put your money into a CD or bond for a set period, and you know exactly what you will receive when that time is up. They are both debt based, meaning that you are the creditor - no different than having a friend ask for $10 today and give you an IOU promising to pay $11 dollars tomorrow. The interest ($1) is collected for the same reason that banks charge interest on loans: to compensate for delaying the ability to spend money. Loaning out $10 deprives you of having that $10 to use now for whatever you wish.

We now know why bonds and CDs fit under the same broad category, but here is how they differ:

1. Issuer: In the case of bonds, the issuer is usually a company trying to raise funds for operations, the development of new products or the opportunity to take over another company. Investment-grade bonds have a very low default risk (the chance that your friend will take your $10 and never come back), but it can definitely happen.

The issuer of CDs is usually a bank because CDs are not issued with the same motives that underlie bonds. CDs are similar to a savings account; they're basically a place to hold your money until you want to do something else with it. Because bonds issued by a company are riskier, they offer a favorable return to the people who buy them. The return on CDs, however, is typically less than bonds but a little better than a savings account.

2. Time/Maturity: This is the sticky part, but also the most significant point. Bonds are longer-term investments, generally maturing in more than 10 years. By contrast, CDs mature in as little as one month and as much as five years. The complication we run into now is that there are further distinctions or categories within the world of fixed-income debt securities, and they overlap everywhere. The loose categorization is as follows (put an imaginary "generally" in front of each description):

T-Bills - mature in less than one year
Notes - mature between one and 10 years
Bonds - mature after a decade or more

In other words, while a bond is technically a fixed-income security with a maturity of more than 10 years, people often use the term "bond" to refer to fixed-income securities in general - even those securities with a maturity of less than 10 years.

The difference in time commitment for bonds and CDs is best expressed in terms of the investor's motives. As previously mentioned, CDs are generally considered short-term, low-risk, interest-paying storage for capital until a more profitable investment can be found. Bonds are considered long-term vehicles for guaranteeing a profit and, perhaps, offsetting some of the risk an investor may face in higher-yield investments such as equities.

To further your understanding of the subtle differences between bonds and CDs, check out Bond Basics Tutorial and Money Market Tutorial.

RELATED FAQS
  1. What is considered a good interest rate for a certificate of deposit (CD)?

    Explore the various options available with certificates of deposit and discover how to find the most lucrative rates for ... Read Answer >>
  2. Why is my bond worth less than face value?

    Find out how bonds can be issued or traded for less than their listed face values, and learn what causes bond prices to fluctuate ... Read Answer >>
  3. What are some safe fixed-income investments?

    Learn what types of fixed income securities provide investors with safe options for protecting principal and providing steady ... Read Answer >>
  4. What happens to the price of a premium bond as it approaches maturity?

    Learn how bonds trade in regard to premiums and discounts, and how bond prices shift closer to par value as bonds approach ... Read Answer >>
  5. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
  6. What is the safest investment?

    Learn about some of the safest investment types. Find out which investment categories offer the best protection on your principal ... Read Answer >>
Related Articles
  1. Products and Investments

    Savings Bonds Vs. CDs: Which Is Better in 2016?

    Understand what a savings bond is, what a CD is and what sets them apart from each other. Learn why a savings bond is the right investment for 2016.
  2. Investing Basics

    CDs or Bonds: Which Investment is Better For You

    When choosing between CDs and bonds, investors who seek to maximize their returns but also want a large measure of safety should consider the following:
  3. Bonds & Fixed Income

    Long-Term Investing With Equity Index CDs

    Equity Index CDs are perfect for investors who don't mind hanging in for the long term.
  4. Insurance

    How To Create A Laddered CD Portfolio

    Laddered certificates of deposit offer safe capital and predictable cash flow, while bringing simplicity to your portfolio.
  5. Bonds & Fixed Income

    Certificates Of Deposit: Conclusion

    Let's recap what we've learned in this tutorial: Safety is a hallmark of the traditional certificate of deposit (CD) sold by a bank or credit union. Investors seeking a low-risk investment ...
  6. Bonds & Fixed Income

    How To Evaluate Bond Performance

    Learn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
  7. Investing

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  8. Bonds & Fixed Income

    Certificates Of Deposit: Bells And Whistles (Part 2)

    The list of features that CDs offer is long and impressive. We explored a number of the varieties in Certificates Of Deposit: Bells And Whistles (Part 1) and will review some additional complex ...
  9. Retirement

    Bond Basics: Conclusion

    Now you know the basics of bonds. Not too complicated, is it? Here is a recap of what we discussed: Bonds are just like IOUs. Buying a bond means you are lending out your money. Bonds are ...
  10. Retirement

    Analyzing The Best Retirement Plans And Investment Options: Bonds

    What they are: Debt securities in which you lend money to an issuer (such as a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value. ...
RELATED TERMS
  1. Fixed-Rate Certificate of Deposit

    A certificate of deposit (CD) which has a set interest rate to ...
  2. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. ...
  3. Term To Maturity

    The remaining life of a financial instrument. In bonds, it is ...
  4. Bond

    A debt investment in which an investor loans money to an entity ...
  5. Bond Ladder

    A portfolio of fixed-income securities in which each security ...
  6. Discount Bond

    A bond that is issued for less than its par (or face) value, ...

You May Also Like

Hot Definitions
  1. Goodwill

    An account that can be found in the assets portion of a company's balance sheet. Goodwill can often arise when one company ...
  2. Return On Invested Capital - ROIC

    A calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. ...
  3. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  4. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  5. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  6. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
Trading Center