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What is a 'Negotiable Certificate Of Deposit (NCD)'

A negotiable certificate of deposit (NCD) is a certificate of deposit with a minimum face value of $100,000, and they are guaranteed by the bank and can usually be sold in a highly liquid secondary market, but they cannot be cashed in before maturity. Due to their large denominations, NCDs are bought most often by large institutional investors, and these institutions often use these as a way to invest in a low-risk, low-interest security.

A Yankee CD would be one example of a NCD.

BREAKING DOWN 'Negotiable Certificate Of Deposit (NCD)'

NCDs are short term, with maturities ranging from two weeks to one year. Interest is paid either at maturity or the instrument is purchased at a discount to it face value.

History of NCDs

NCDs were introduced in 1961 by First National City Bank of New York, which is now Citibank. The instrument allowed banks to raise funds, which could be used for lending. NCDs were designed to ease a deposit shortage that had affected banks during the previous decade. Many bank depositors transferred their cash from checking accounts, which did not pay interest, to other investments such as Treasury bills, commercial paper and bankers' acceptances.

The First National City Bank of New York lent $10 million to a New York government securities broker in government securities, which agreed to accept trades in certificates of deposits. This created a secondary market in which the NCDs could trade. By 1966, investors held $15 billion in outstanding NCDs, which grew to over $30 billion in 1970 and $90 billion in 1975.

The Market

Participants in the market are comprised primarily of wealthy individuals and institutions. Institutions include corporations, insurance companies, pension funds and mutual funds. It attracts those seeking a return on cash in a low-risk and liquid investment.

Safety

A feature of the NCD is its low risk. NCDs are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per depositor per bank. This was increased from $100,000 in 2010 with the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Therefore, the product attracts those who would invest in other low-risk investments, such as U.S. Treasury securities.

Callable NCDs

Most NCDs are not callable, meaning the bank cannot redeem the instrument prior to the maturity date. However, if a bank can call the NCD, it will do so when interest rates fall. Hence, investors will have difficulty finding another NCD that pays a similar rate of interest. The initial rate to the NCD holder will be higher to compensate the investor for this risk.

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