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. 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. How safe an investment is a certificate of deposit?

    Discover certificates of deposit, their basic makeup and numerous variations, and understand why they are some of the safest ... Read Answer >>
  3. Can certificates of deposit (CDs) lose value?

    CDs are FDIC insured, so they do not lose face value, though broker-issued CD accounts do carry risks. 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. Are Certificates of Deposit (CDs) Taxable?

    Learn the tax consequences on certificates of deposit, how they are reported and how penalties on early withdrawals can affect ... Read Answer >>
  6. Are certificates of deposit a kind of bond?

    There is a fair amount of overlap between certificates of deposit (CDs) and bonds; they are both fixed-income securities, ... Read Answer >>
Related Articles
  1. Markets

    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 ...
  2. Personal Finance

    Certificate of Deposit (CD)

    A certificate of deposit, or CD, is a common financial product sold by banks, thrift organizations and credit unions. This type of product is often called a time deposit. CDs are insured up to ...
  3. Personal Finance

    How To Create A Laddered CD Portfolio

    Laddered certificates of deposit offer safe capital and predictable cash flow, while bringing simplicity to your portfolio.
  4. Personal Finance

    Are CDs Good Protection For The Bear Market?

    Certificates of deposit promise stable income in any market, but do they deliver?
  5. Markets

    How To Earn The Most From CDs When Interest Rates Are Low

    Certificates of deposit might not seem like a good place to keep your money when interest rates are low, but they do offer security and stability. And with laddering and studying promotional ...
  6. Markets

    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. Managing Wealth

    Save Smart With A CD Ladder

    A CD Ladder allows you to stagger your investments and take advantage of higher interest rates.
  8. Personal Finance

    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.
  9. Markets

    Getting Certificates of Deposit (CDs) in Emerging Markets: Risks and Rewards

    Learn about the risks and rewards associated with investing in a certificate of deposit (CD) offered by an emerging market and what to consider before buying.
  10. Personal Finance

    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.
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. Fixed-Rate Certificate of Deposit

    A certificate of deposit (CD) which has a set interest rate to ...
  4. Promotional CD rate (Bonus CD rate)

    A limited-time offer of a higher rate of return on a certificate ...
  5. CD Ladder

    A strategy in which an investor divides the amount of money to ...
  6. Index-Linked Certificate Of Deposit

    A certificate of deposit (CD) with a return based on a specific ...
Hot Definitions
  1. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  2. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  3. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  4. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  5. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
  6. Enterprise Value (EV)

    A measure of a company's value, often used as an alternative to straightforward market capitalization. Enterprise value is ...
Trading Center