What Is a CD Bond and How Is It Different From CDs & Bonds?

Certificates of Deposit (CDs) and bonds represent investment options. CDs are time-deposit accounts offered by banks, providing a fixed interest rate for money held for a predetermined period. Bonds, conversely, are debt instruments issued by governments or corporations to raise capital, promising regular interest payments and repayment of principal at maturity. Understanding “CD bonds” and their differences from traditional CDs and bonds is important for informed financial decisions.

Defining CD Bonds

A financial instrument often referred to as a “CD bond” is more accurately known as a brokered Certificate of Deposit (CD). Brokered CDs are issued by a bank but purchased through a brokerage firm, distinguishing them from CDs bought directly. Brokered CDs function as fixed-income investments, offering a set interest rate over a specified term. The underlying deposit remains an obligation of the issuing bank, not the brokerage firm, an important distinction.

Brokerage firms acquire large blocks of CDs from various banks and then divide them into smaller denominations, typically $1,000 increments. This allows investors to access CDs from many banks through one brokerage account. Brokered CDs are designed to be tradable on a secondary market, providing a level of liquidity not found with traditional bank CDs.

Key Features of CD Bonds

Brokered CDs come with a wide range of maturity dates, from as short as three months to as long as 20 years or more. Interest payment structures can vary, with some paying simple interest periodically, such as monthly, quarterly, or semi-annually, while others pay interest at maturity, especially for shorter terms. Unlike traditional bank CDs, interest on brokered CDs does not compound within the CD itself but is deposited into the investor’s brokerage cash account.

Some brokered CDs are callable, meaning the issuing bank can redeem them before maturity. Banks exercise this option when interest rates decline, allowing them to reissue debt at a lower cost. Callable CDs offer a slightly higher interest rate to compensate investors for this risk.

Brokered CDs are eligible for Federal Deposit Insurance Corporation (FDIC) coverage, protecting up to $250,000 per depositor, per issuing bank. This coverage extends to the principal amount and any accrued interest, but not to any premium paid above par value in the secondary market. Investors can expand their FDIC protection by purchasing brokered CDs from multiple distinct banks through a single brokerage account, as each bank’s CDs are separately insured up to the limit.

Comparing CD Bonds with Other Investments

Brokered CDs share similarities with both traditional bank CDs and corporate or government bonds. Traditional bank CDs are purchased directly from a financial institution and carry penalties for early withdrawal. In contrast, brokered CDs can be sold on a secondary market, offering greater liquidity without incurring early withdrawal penalties, although selling before maturity may result in a gain or loss depending on market conditions. Traditional CDs compound interest within the account, while brokered CD interest is paid out to a brokerage cash account.

When compared to corporate or government bonds, brokered CDs have different issuers and risk profiles. Brokered CDs are obligations of FDIC-insured banks, meaning they carry a lower credit risk than most corporate bonds due to the federal insurance backing. Corporate bonds are issued by companies and their safety depends on the company’s financial health, lacking FDIC insurance.

Government bonds, such as U.S. Treasuries, have minimal default risk, but they are not FDIC-insured deposits. Interest earned on brokered CDs is taxed as ordinary income at the federal level, similar to interest from corporate bonds. However, interest on U.S. Treasury bonds is exempt from state and local income taxes, a benefit not offered by brokered CDs.

Acquiring and Selling CD Bonds

Investors acquire brokered CDs through a brokerage account, which serves as the platform for purchasing and managing these instruments. Brokerage firms offer access to both new issue brokered CDs and existing brokered CDs available on the secondary market. New issues are sold at par value, often $1,000, and do not incur a trading fee upon purchase.

The secondary market provides the opportunity to sell brokered CDs before their maturity date, offering a degree of liquidity that traditional bank CDs lack. However, the market value of a brokered CD can fluctuate based on prevailing interest rates and other market conditions. If interest rates have risen since the CD’s issuance, its market value may be less than the original purchase price, potentially leading to a loss upon sale. Conversely, if rates have fallen, the CD could sell for a premium.

Brokerage firms may charge a trading fee or markup/markdown for transactions on the secondary market. Interest earned on brokered CDs is considered taxable income in the year it is earned, regardless of whether the CD has matured, and is reported to the IRS on Form 1099-INT.