A:

To address this question, let's employ the concept of distance. In the city, a short taxi ride from your hotel to a convention center might cost about $5.00. However, when you depart from your hotel for a ride to the airport located outside the city limits, you're more likely to pay more than $30.00. The taxi fare is simply a matter of the longer the ride, the higher the fare.

The short answer, then, relates to the difference in a certificate of deposit's (CD) maturity, i.e., the length of time a depositor's money is tied up in or committed to the issuer. So, the longer a bank has contractual use of the funds, the more interest it must pay to attract this type of money from depositors. That's how competition affects financial markets.

Banks are the usual issuers of CDs. Individuals, companies and organizations are commonly the depositors that put their money into these financial instruments. The interest payable on a CD is the cost (to the recipient bank) for using the money. The interest receivable on the CD is the return (to the depositor) for providing the money. CDs are issued for periods ranging anywhere from 90 days to five years, and, generally speaking, the longer the term of the CD, the better the interest rate paid to the depositor.

As a rule, in financial markets, the longer money is being used or provided by a borrower or a lender, respectively, it is going to carry a higher rate of interest. We generally think of banks as lenders, but, obviously, for a bank to lend money it must obtain funds to perform this function. One of a bank's principal funding mechanisms for this purpose is to "borrow" money from the marketplace in the form of CDs. In order to stabilize its funding, it issues some of its CDs with longer maturity dates (two to five years) and is willing to pay depositors a higher rate to attract these funds.

For more on CDs, check out The Money Market tutorial.

RELATED FAQS
  1. Besides a savings account, where is the safest place to keep my money?

    Savings accounts are safe because investors' deposits are guaranteed by the Federal Deposit Insurance Corporation (FDIC) ... Read Answer >>
  2. 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 >>
  3. What are the typical durations for a certificate of deposit?

    Investing in a certificate of deposit offers individuals the ability to earn interest on idle funds with less risk than stock ... Read Answer >>
  4. I would like to invest in either an IRA or CD. Any recommendations?

    I'm getting ready to receive a WC settlement of approx. $125k. I am 52 and disabled but I can't collect on any disability ... Read Answer >>
  5. How are yields taxed on a certificate of deposit (CD)?

    Learn how interest earned on a certificate of deposit is taxed and how this may reduce the total return of an investment ... Read Answer >>
  6. Why is the capital adequacy ratio important to shareholders?

    Understand what the capital adequacy ratio is and why it is a very important metric of financial soundness for evaluating ... Read Answer >>
Related Articles
  1. Bonds & Fixed Income

    Certificates Of Deposit: Bells And Whistles (Part I)

    Beyond the basic model, there are CDs with many features. We'll explore some of the various options, beginning with add-on CDs and ending with zero-coupon CDs in the next section. Some of the ...
  2. Insurance

    Are CDs Good Protection For The Bear Market?

    Certificates of deposit promise stable income in any market, but do they deliver?
  3. 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:
  4. Savings

    Money Market vs. CDs: Which Is the Better Investment?

    Find out which short-term savings vehicle, a money market account or a certificate of deposit, is a better investment for your needs.
  5. 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 ...
  6. Bonds & Fixed Income

    CDs Vs. Inflation: Are They Keeping Up?

    Learn how to determine whether the money invested in certificates of deposit (CDs) can keep pace with the rate of inflation and how you measure inflation.
  7. Savings

    Explaining Term Deposits

    A term deposit (more often called a certificate of deposit or CD) is a deposit account that is made for a specific period of time.
  8. Investing News

    These Are the Best Places to Put Your Cash Now

    If you are looking for a good place to put your money right now, here are a few ideas that can put—or help you keep—a little more coin in your pocket.
  9. Bonds & Fixed Income

    Certificates Of Deposit: Safety And More!

    Most investors consider a CD to be a safe, conservative place to hold assets. The assets don't just sit there, though. They earn interest in return. Traditional CDs typically yield returns greater ...
  10. Investing Basics

    What is a Bank?

    A bank is a financial institution licensed to receive deposits or issue new securities to the public.
RELATED TERMS
  1. Certificate Of Deposit - CD

    A savings certificate entitling the bearer to receive interest. ...
  2. Brokered Certificate Of Deposit

    A certificate of deposit (CD) that is purchased through a brokerage ...
  3. Index-Linked Certificate Of Deposit

    A certificate of deposit (CD) with a return based on a specific ...
  4. Time Deposit

    A savings account or certificate of deposit (CD) held for a fixed-term, ...
  5. Callable Certificate Of Deposit

    An FDIC insured certificate of deposit (CD) that contains a call ...
  6. Yankee CD

    A certificate of deposit (CD) that is issued in the United States ...
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center