Computing Yields on Enhanced CDs
Robert E. Brooks · Financial Services Review · 1996
In this paper, we seek to provide a framework for comparing certificates of deposit (CD) products that vary in their features. There are now fixed-rate CDs with no early withdrawal penalties as well as floating-rate CDs with guaranteed floors. With the model developed here, we examine the required change in the effective annual rate required in basis points to make CD products with embedded derivatives (called enhanced CDs) comparable with the standard CD products (ones with large early with- drawal penalties). This framework is beneficial for both retail customers seeking to make rational comparisons and bank executives seeking to provide optimal liability products and seeking to manage the resulting interest rate risk