What is a 'Bear CD'

Bear CD is a certificate of deposit with an interest rate that fluctuates in inverse correlation to the value of an underlying market index. In other words, the interest rate paid on the CD increases as the underlying market index decreases in value.

BREAKING DOWN 'Bear CD'

A bear CD can in some ways offer the best of both worlds, within moderation, for an investor. They are considered are relatively safe and secure investment option, and involve a minimal level of risk. The investor’s principal stays safe and intact, with they also earn a minimal amount of interest in the form of a guaranteed rate of return. So this aspect offers a way to play it safe and make major losses unlikely.

At the same time, if the market takes a downturn, the investor has the potential of seeing additional returns and realizing greater profits. If the index linked to the bear CD goes down, the holder will earn additional interest.

The bear CD has a counterpart that works in an opposite way: the bull CD. As those experience with bear and bull markets may be able to guess, a bull CD works in alignment with the related market index. It pays at an interest rate that corresponds to the rising index. If the interest rate falls, however, the CD still pays a minimal guaranteed rate.

Ways to Use a Bear CD

This type of CD is used for two main purposes: speculation or hedging. An investor may want the safety of a CD but with the market exposure of a bear CD. This CD is bearish because the investor is betting that the market will fall during the life of the CD. This is also known as betting against the market.

This type of instrument is also used to hedge actual market positions. If an investor has a long position that is highly correlated to the underlying market index, they may invest their excess cash in a bear CD, which can offset losses in the market investment. This is a way to help balance out the portfolio and help offset or level off losses or fluctuation that may occur elsewhere.

Bear CDs are typically used as a hedging instrument by more experienced, knowledgeable investors since this is considered a relatively sophisticated strategy. For those investors who understand the nuances of bear CDs, though, this can be a potentially rewarding investment vehicle to include in a larger, diversified portfolio.

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