Financial Management

Q.1.(a) Distinguish between a negotiable certificate of deposit and the certificates of deposit discussed in the section “Non-marketable securities”.

Ans. NEGOTIABLE CERTIFICATE OF DEPOSIT (CD)

Basically Negotiable Certificate of Deposits are marketable receipts for large deposits held by a bank for a specified time period and interest rate. For example ABC Bank sells a $ 100,000 CD for 6 months at 8.5%. The holder can resell the CD any time prior to 6 months. Banks use CDs to gather funds from Corporations and other institutions to finance their operations. CDs have denominations of $ 25000 to $ 10 million, pay both interest and principal at maturity, and usually have maturities of 6 months or less. The return on CDs suggest that CDs are riskier than Treasury Bills. While there is an organized and active secondary market for the CDs of larger banks, the holders of CDs recognize that deposits over $ 100,000 are uninsured. Thus the risk of default exists for CDs...