Annual Percentage Yield (APY) - The percentage amount ordinarily advertised on
interest-bearing deposit accounts (savings accounts, checking accounts and CDs). Truth in Savings
regulations require this number be reported and it reflects the total interest to be received over
a 365-day year, regardless of the bank's own method of compounding (daily, weekly, monthly, etc.).
Therefore, the use of APY creates a level playing field through which to compare returns from bank
accounts and CDs that may use differing compounding methodology.
Basis point - One percentage point of one percent. The difference between 2.00%
and 2.01% is one basis point. The difference between 2.00% and 2.02% is two basis points. The
difference between 2.00% and 2.50% is fifty basis points.
Current Yield - The percentage return on a bond or CD based on its current market
price and its original interest rate. A bond or CD for which you paid $1,000 and that pays you $60
annually would have a current yield of 6%. A bond or CD for which you paid $1,000 and that pays
you $30 semi-annually with the $30 annual payments accruing interest so that it pays $31.80 in the
second annual payment also has a current yield of 6%, but it has an APY of 6.18%.
Discount - The amount under face value paid for a security. A security trading at
99% of face value is said to be trading at a 1% discount under par. A security trading exactly at 100%
of face value is trading at par value. A CD trading above the face or par value trades at a premium.
Brokered CDs may trade at a discount or premium (and these are not recommended), but discounts or
premiums on CDs are exceptionally rare.
Hedge - An investment made to minimize the impact of adverse movements in interest
rates (or securities prices).
Issuer - The entity that issues a debt security and is obligated to pay interest
and principal. Except with brokered CDs (not recommended), bank CDs are issued only by the issuer,
its parent entity or an entity in the same corporate family. Especially with online banks, you need
to know who the parent company is as that is the issuer of CDs (and bank under whose FDIC certificate
savings accounts are held). It is important to know the issuer in order to avoid exceeding FDIC
(or NCUA) insurance limits. For example, IGoBanking, BankPurely and GiftsforBanking.com are all
trade names for a single issuer (Flushing Bank).
Laddering - A hedging technique for reducing the impact of interest-rate risk
by structuring a portfolio with different instruments that mature at different dates. CD laddering
involves protecting from the impact of a dramatic move in interest rates by buying CDs with different
Liquidity - The ability to quickly convert an investment into cash. A savings or
money market account that you can withdraw money from at any given moment without a penalty always
offers the best liquidity. Other investments that allow quick conversion to cash, such as a
No Penalty CD, can also offer excellent liquidity. CDs generally are less liquid than savings,
but may offer a certain amount of liquidity if the bank allows withdrawal with payment of a
reasonable early withdrawal penalty. Long-term bonds are generally considered less liquid
(some bonds aren’t liquid at all). Real estate investments are perhaps the least liquid
Maturity - The date on which the issuer of a security, such as a CD, is obligated
to redeem the security (exchange the security for cash in the amount of face value plus accrued interest).
Put - A right to sell a security at a certain price at a specified time, usually
given for a payment of some sort. Some consider a reasonable early withdrawal fee to be a form of a
put on a CD. No Penalty CDs have a built in put.
Secondary market - Market for issues previously offered or sold.
Zero coupon bond (or CD) - A bond (or CD) on which no periodic interest payments
are made. The investor receives one payment at maturity that includes the repayment of principal and
all interest accrued. Zero coupon CDs are rare as customers are responsible for paying interest in
the year in which it is accrued (except for rare cases of CDs of one year or less).
Zero coupon municipal bonds are more commonplace.