Callable Certificates of Deposit Callable CDs offer significantly higher yield in return for granting issuers the right to retire CDs prior to maturity. The tradeoff betweenhigh yield and uncertain maturity, inherent to Callable investments, is attractive formany investors. To "call" a CD is to retire it. Although Callable CDs are issued withstated maturities of three to twenty years, most are retired (by the issuer) at somepoint prior to maturity. Investors who purchase Callable CDs do not know how long they will remain outstanding.
Callable CDs can be called only by the issuing bank prior to maturity. In order to achieve flexibility in managing their
balance sheets, banksreward CD investors with a higher rate of interest on Callable CDs in return for the right to
call, or pay back the investors principal (at the bank's discretion only). Investors who want to receive as much interest income as possible and are willing to accept an uncertain final maturity might consider Callable CDs.
Callable CDs are offered in a wide range of maturities, typically three (3) to twenty (20) years, and are available in minimum denominations and in increments of $1,000. The non-call period, or "lockout" period, (the time during which an issuer cannot call the CD) is usually one (1) to five (5) years. Interest payments are made either monthly or semi-annually. Callable CDs are available in Fixed-Rate, Step-Up and Zero Coupon structures, allowing investors to choose the CD that best fits their cash flow requirements.
A call provision does not give the investor the right to redeem the CD. Banks and deposit brokers must inform investors that the CD is callable. However, the APY on a callable CD is not required to reflect the call feature. This will be significant if theCD has step rates because the CD could be called before the CD steps to a more favorable rate.In that case the investor will receive less than the advertised APY.
What causes a CD to be called?
After the initial non-call period, the issuing bank has the right (but not the obligation) to call the CD for any reason prior to its stated maturity. As a practical matter, an issuer will generally decide to call a CD when it determines that the level of interest rates, the shape of the yield curve and volatility of interest rates are such that it can issue a new CD at a lower rate than the existing CD. Investors considering an investment in Callable CDs should note that it is unlikely that they would be able to replace their called CD with one that pays an equivalent interest rate (the "reinvestment risk") under this scenario. However, the interest rate available on a new Callable CD may still be greater than the rate on Non-Callable CDs at the time the original CD could have been purchased.
Research shows that the actual life of most Callable CDs is much shorter than stated maturity.
Expected Life Simulation:
Hypothetical 10-year, non-callable 1 year, 1989-1999 (for illustration purposes only)