What Are Structured CD Rates and How Are They Different

When you have a CD of bonds or other securities, the market sets a fixed return for those bonds. Structured CD rates are very similar, except instead of limited returns, structured rates are based on various conditions that investors agree to meet. They can be cash-like positions or even hedge funds for the more affluent investor.

What Are Structured CD Rates?

Structured CD rates offer an appealing package to investors who want both fixed income and potential growth in one security. Structured CD rates are certificates of deposit that have a fixed rate and a maturity date and include a second variable rate calculated based on an underlying investment. The investor chooses what the underlying asset will be and can change that at any time.

The main benefit of structured CDs is that they will pay a predictable return based on the specific structure of the CD. However, this predictability is also what can make them risky. If the conditions are met, and you fail to meet them, you may lose a substantial amount of your deposit.

Why Use Structured CDs?

Structured CD rates are not for everyone who wants to invest their money. It is best for those with specific needs and goals that a typical certificate of deposit cannot provide. Investors who buy structured CDs usually have a set plan regarding how much they are looking to invest in a CD, along with a time frame they wish to achieve their goal.

The other factor is the investor’s risk tolerance and understanding of the risks involved with a structured CD investment. It is also essential to have a good knowledge of the conditions for the CD. Some of them may include risk-free interest, growth based on market conditions, or even an option to have a fixed rate return.

How Do You Buy Structured CDs?

It is essential that when you buy structured CDs, you read the product disclosure statement wholly and thoroughly before making your decision. These CDs will typically have a minimum deposit amount, and a CD can be in the millions of dollars. If you are interested in making a smaller investment, the investment companies that offer structured CD rates may allow you to make only a partial deposit. You can also look into bond funds and other securities that will give you a fixed rate of return, similar to the return-based CDs offered by banks.

Types of Structured CDs

Structured CDs can be divided into two broad categories: factor-based CDs and option-based CDs.

Factor-Based CD’s

A factor-based structured CD is similar to a fixed-income investment that you can buy in the market. Still, instead of providing you with a predictable return based on interest rates, it provides you with a predetermined return based on one or more underlying factors. In the same way that fixed-income investments are purchased in the market with predetermined returns based on yield and maturity of time, factor-based CDs will provide predictable returns based on the value of one or more underlying securities.

For instance, an investor may invest in a factor-based CD of a stock portfolio. The CD will then pay an interest rate based on the performance of the portfolio rather than the market interest rates.

Option-Based CD’s

An option-based structured CD is similar to the fixed-income investment options you find in the market, including bonds, except you are investing into various options at fixed amounts with predetermined returns based on factors.

These options can be based on interest rates, commodity prices, or equity prices. When you purchase an option-based CD, you are essentially purchasing the rights to buy or sell assets at a given price within a specific time frame.

What Is the Appeal of a Structured CD?

The appeal of a structured CD is the potential for higher-than-average interest rates because the investor can choose an investment that shows growth potential. If the underlying asset fares well over the certificate’s term, it can result in a higher return than might be available through conventional CDs.

Structured CDs also offer something else: they come in different forms, providing greater flexibility and more control than traditional ones. A variable-rate CD has a variable rate of return that changes with the underlying investment. It can also be structured as an ascending CD, in which case the interest rate increases over time.

CDs can also have a step-up CD feature that increases at various intervals throughout the term of the CD. For example, it could increase once every six months during a two-year term or once per year for the same period. The latter can be structured as an interest-only CD, in which case the amount of interest paid does not increase with maturity.

How Are Structured CDs Different From Traditional CDs?

Conventional savings products, such as a traditional CD, have a fixed rate. If interest rates go up, it can result in a loss of money on your savings.

In contrast, you know exactly how much interest will accrue over the certificate’s term with a variable-rate CD. However, the rate of return is influenced by an underlying investment you choose and can change at any time. For instance, if you are interested in a higher yield but want to avoid losing money during periods when interest rates go down, you may opt for an interest-only CD.

With the right investment strategy, earning a higher return than would be available on a traditional savings product is always possible. There is no limit to that potential. It can be even more significant when the bank’s rates are higher than those of other financial institutions.

The Risks Associated With a Structured CD

The risks associated with a traditional CD include the possibility that interest rates will drop, causing you to lose money. This is less of a chance with a variable-rate or step-up CD since there is always the possibility that interest rates will rise. However, it’s still possible that your investment could lose some or all of its value over the product’s life.

The other major risk associated with a structured CD is that the underlying investment you’ve chosen will fail to provide the growth you had hoped for. The FDIC still guarantees the CD, but if the investor’s financial situation isn’t in good order, they could have difficulties earning a return on their money.