Treasuries vs. CDs: Differences, similarities, and portfolio

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Treasuries vs. CDs: Differences, similarities, and portfolio

Postby linuxizer » Sat Jan 09, 2010 12:17 pm

Hi folks,

I have briefly attempted to summarize some of the key differences and similarities between CDs and Treasuries, as well as how those differences play out in portfolio construction.

While CDs are often thought of as different assets than bonds, in reality they are simply bonds with special characteristics. These differences and similarities will be explored below.

Because CDs, like U.S. Treasuries, are backed by the full-faith and credit of the U.S. Government, Treasury Bonds are the appropriate comparison. Furthermore, because there is no functional difference in the behavior of a rolling bond ladder and a bond fund,in the interests of brevity, in the interests of brevity, the term "bond" on this page can be taken to mean U.S. Treasury bonds or Treasury bond fund.

Characteristics and Risks

In general, assuming yields are equal, CDs are preferred to bonds in rising-interest-rate environments, whereas Treasuries are preferred to CDs in falling-rate environments.

* Liquidity - Treasuries are the most liquid bond market in the world. CDs, by contrast, cannot typically be traded; even brokered CDs have fairly high spreads. In a rising rate environment, this lack of liquidity is not a problem if the CD has a put option (see below). In a falling rate environment, however, liquidating the bond for purposes such as rebalancing, tax management, or funding unexpected life events, becomes costly (at risk is exactly equivalent to the increase in market value of a bond in a falling rate environment).

* Options - Many CDs have a put option which allows the bondholder to receive the premium back from the bank in exchange for a penalty (typically 3-6 months of coupon payments). In a rising rate environment this can be a valuable feature of CDs. Treasuries no longer have embedded call options, and CDs do not have call options. However, CDs are subject to a certain type of call risk--the risk that if a bank goes under, the FDIC will not continue to honor the terms of the original bond agreements. The amount at risk is exactly equivalent to the increase in market value of a bond in a falling rate environment.

* Purchasing convenience - Some individuals prefer dealing directly with their local bank; others prefer dealing with a broker of their choice.

* Credit risk - Both CDs and Treasuries are obligations of the U.S. Government, and are therefore considered to have no credit risk. CDs must remain under certain purchase limits to maintain this feature.

Market history

Because CDs cater primarily to the individual investor market, whereas Treasuries can be traded in large volumes by institutional investors as well, and because the characteristics of the bonds differ (particularly with regards to liquidity and options), yields on Treasuries and on CDs are never exactly alike.


This is a very lazy first stab at things, and I am sure I have missed key points, as well as thoroughly offended one camp or another ;-). Let's discuss this here, and then I or someone else can update the wiki ( http://www.bogleheads.org/wiki/CDs_vs_Bonds ) with our findings.

Also, I have long been curious about the historical market rate differences between the CD and Treasury yield curves. Treasury's easier to find, but CDs much less so (not least because there's no one rate for CDs, only an average and a min/max). Does anyone have that info?
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Postby Bob's not my name » Sat Jan 09, 2010 12:44 pm

in the interests of brevity, in the interests of brevity

This is brilliantly ironic.

CDs do not have call options

In the interest of brevity, you may not want the wiki to get into a lot of arcane detail, but there are callable CDs. Furthermore, I think the death put feature ought to at least be mentioned.
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Postby dm200 » Sat Jan 09, 2010 12:44 pm

1. For large amounts being invested, you run into the Federal Insurance limit of $250,000.

2. Note that federally insured credit unions have the same backing of the full faith and credit of the US Government.

3. If you depend on the ability to redeem a CD early, make sure you have that right. Most CDs issued directly by financial institutions provide it, but some do not.

4. Brokered CDs, while marketable on the secondary market, do not offer the right to redeem early.

5. Because the CD may be redeemed early if the issuing bank or credit union fails, there is a degree of call risk.

6. There are bump up CDs, available from some financial institutions, that allow getting a higher rate if rates go up. There are a lot of tricks, though, that the issuung banks and credit unions have in these programs, so be careful.
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Postby spam » Sat Jan 09, 2010 1:07 pm

Hi linuxizer,

I don't understand the reasoning for this:

In general, assuming yields are equal, CDs are preferred to bonds in rising-interest-rate environments, whereas Treasuries are preferred to CDs in falling-rate environments.


There are many different types of CD's. There are two types of inflation indexed CD's (they are rare) and some CD's are callable. Also, there is a "step up" CD that may allow you to exchange it for a higher yield without penality. There are also differences between Brokered CD's and your typical bank or Credit Union CD.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby Doc » Sat Jan 09, 2010 1:14 pm

linuxizer wrote: I have briefly attempted to summarize some of the key differences and similarities between CDs and Treasuries, as well as how those differences play out in portfolio construction.

The gist is right but some of the details are not accurate.

I don't think CDs have the "full faith and credit" guarantee but it is a close second.

Future interest is not guaranteed on a CD. (You have it but its not really clear.)

I think the "what if I need to exit early" concept needs to be elaborated and stressed more. I think for some this is one of the major drawbacks of CDs. Remember if you sell a Treasury that money is available at the same broker immediately. And available for wire out the next business day.

The whole better/worse gets into the fund/ladder discussion and may not really be applicable here. They are both FI and once you commit you are stuck with the yield for better or worse for the duration unless you sell and and buy something with different risk attributes.

Anyway, it's a good start. Good luck with it.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby Lucio » Sat Jan 09, 2010 1:16 pm

linuxizer wrote:Also, I have long been curious about the historical market rate differences between the CD and Treasury yield curves. Treasury's easier to find, but CDs much less so (not least because there's no one rate for CDs, only an average and a min/max). Does anyone have that info?


Nice work. For short term CD rates, the Federal Reserve's data may be a reasonable proxy. There are two data series that may work, one for short term commercial paper and one for secondary market CDs. Both are here:
http://www.federalreserve.gov/Releases/H15/data.htm

The CD series begins in 1964.

I have seen another series somewhere else, but I just can't remember where at the moment.

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Postby dm200 » Sat Jan 09, 2010 3:06 pm

I don't think CDs have the "full faith and credit" guarantee but it is a close second.


Yes, they DO! IF, they are federally insured by the FDIC (banks and thrifts) or NCUA (credit unions).

Just to cite a credit union example, the Federal Credit Union Act (passed by Congress and signed by the President), as amended, requires the sign at every federally insured credit union "shall include a statement that insured shareaccounts are backed by the full faith and credit of the United States Government"

Seems pretty clear to me, unless you are some sort of conspiracy theorist who claims that Congress and the President have no right or authority to pass and sign bills into law.
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Data

Postby Barry Barnitz » Sat Jan 09, 2010 3:25 pm

Also, I have long been curious about the historical market rate differences between the CD and Treasury yield curves. Treasury's easier to find, but CDs much less so (not least because there's no one rate for CDs, only an average and a min/max). Does anyone have that info?


I am not sure how much help this will be, but I have posted links to the FRED data series links from the St. Louis fed in the wiki discussion page.

The links provide long term data on 1 month to 6 month CDs and treasury bills.

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Postby Doc » Sat Jan 09, 2010 4:15 pm

dm200 wrote:
I don't think CDs have the "full faith and credit" guarantee but it is a close second.


Yes, they DO! IF, they are federally insured by the FDIC (banks and thrifts) or NCUA (credit unions).



I thought they might be in the "agency" status like Fannie Mae instead of the "full faith and credit" guarantee like Ginnie Mae but that there was a better temporary guarantee as a result of the bail out. I could be incorrect.
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Postby dm200 » Sat Jan 09, 2010 4:54 pm

Doc wrote:
dm200 wrote:
I don't think CDs have the "full faith and credit" guarantee but it is a close second.


Yes, they DO! IF, they are federally insured by the FDIC (banks and thrifts) or NCUA (credit unions).



I thought they might be in the "agency" status like Fannie Mae instead of the "full faith and credit" guarantee like Ginnie Mae but that there was a better temporary guarantee as a result of the bail out. I could be incorrect.


The FDIC web site http://www.fdic.gov/consumers/banking/c ... ymbol.html has a lot of information about FDIC coverage, and includes this:

Full Faith and Credit of U.S. Government

FDIC deposit insurance is backed by the full faith and credit of the United States government. This means that the resources of the United States government stand behind FDIC-insured depositors.
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Re: Data

Postby tfb » Sat Jan 09, 2010 4:56 pm

Barry Barnitz wrote:The links provide long term data on 1 month to 6 month CDs and treasury bills.

I wish there's a series on 1-, 2-, and 5-year CDs. Conceptually the best CD yields should always be higher than Treasurys for the same term.
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Postby MCSquared » Sat Jan 09, 2010 8:02 pm

dm200 wrote:
I don't think CDs have the "full faith and credit" guarantee but it is a close second.


Yes, they DO! IF, they are federally insured by the FDIC (banks and thrifts) or NCUA (credit unions).

Just to cite a credit union example, the Federal Credit Union Act (passed by Congress and signed by the President), as amended, requires the sign at every federally insured credit union "shall include a statement that insured shareaccounts are backed by the full faith and credit of the United States Government"

Seems pretty clear to me, unless you are some sort of conspiracy theorist who claims that Congress and the President have no right or authority to pass and sign bills into law.


I am not sure on the credit union insurance fund, but I do not believe it is as clear on FDIC. It is my understanding that in 1987 Congress passed a non-binding resolution about Federal backing but to date there is no law or statute that strictly binds Treasury to fund the FDIC. In fact, I think the laws that have been passed strictly allow the FDIC to borrow from the Treasury.
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Postby linuxizer » Sat Jan 09, 2010 8:15 pm

I hadn't yet added in info about other types of CDs (including credit unions, callable, inflation-indexed, commodity-indexed, etc.). Much of that properly belongs on the CD wiki page rather than the CD vs. bond page, but I'll make it more explicit that the comparison in for plain-vanilla CDs.

I'll clarify as some have suggested, and work on graphing the data helpfully provided.

Adding in the death put feature is worth doing. As is removing the unintentional irony. :oops:

So far, fairly uncontroversial. Keep 'em coming.

Thanks,
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Postby musbane » Sat Jan 09, 2010 11:39 pm

As far as the put aspect is concerned - from my own work recently in setting up several 5 year CDs as well as reading and contributing to several CD threads, it is clear that some providers will not let you cancell unless they want to. Others spell out the penalties if you do cancell, but don't say up front in writing that cancellation is your unilateral right. This group will verbally say it is, but a carefull person must imagine that if/when one wants to cancell, it is likely that thousands of others will also. And that that will be precisely when the bank will really, really rather you didn't. And will be looking closely at their contract.
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Postby joe8d » Sun Jan 10, 2010 12:20 am

1. For large amounts being invested, you run into the Federal Insurance limit of $250,000.


You can increased the FDIC coverage by adding POD beneficiaries to your accounts.The coverage is increased by a multiple of the number of the beneficiaries you list.I'm doing that myself.
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linuxixer

Postby Barry Barnitz » Sun Jan 10, 2010 1:59 am

Hi:

Sorry, but none of this makes any sense to me.

In general, assuming yields are equal, CDs are preferred to bonds in rising-interest-rate environments, whereas Treasuries are preferred to CDs in falling-rate environments.


In a rising interest environment, what advantage does a 3 month CD have over a 3 month tbill; a six month CD have over a 6 month tbill or a 1 year CD have over a 1 year tbill? All an investor would do is roll the investment over to a new higher yielding CD or bill at maturity.

Now the situation might be different if it we extend maturities to a 2 year CD/ 2 year note or a 5 year CD/ 5 year note. We would have the option of selling the CD/Note early, and investing the proceeds in a new higher yielding security. With the CD, we would pay an early withdrawal interest penalty. With the note, we would accrue interest up to the point of sale, but in a higher interest environment would most likely have to sell the note at a sllght discount to par and also take the haircut of transaction costs for a small transaction on the market. Without providing the numbers one cannot determine which instrument would provide the higher value for a sale prior to maturity.

In the case of falling rates, most holders of CDs and bills and notes would be inclined to hold and enjoy the higher yielding securities until maturity and enjoy the higher yields. In this instance for a longer duration holding, a sale prior to maturity should result in a modestly higher value for the note holder compared to a sale in a higher interest rate envioriment, simply because the decline in rates should produce a slightly higher premium value for the bond at sale. Whether this after transaction cost value for the note would exceed the after early withdrawal value of the CD holder would depend on the numbers.

What is true, is that the CD investor is subject to federal and state taxation on the interest. The t-bill and t note investor is only subject to federal tax.

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Re: linuxixer

Postby linuxizer » Sun Jan 10, 2010 6:47 am

Hi Barry,

Thanks for pointing out a further restriction (that for maturities which are shorter than most ST funds would hold, the options don't really come into play), and the taxation issue.
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Postby fsrph » Sun Jan 10, 2010 10:47 am

joe8d wrote:You can increased the FDIC coverage by adding POD beneficiaries to your accounts.The coverage is increased by a multiple of the number of the beneficiaries you list.I'm doing that myself.


I wonder if I was told the correct info from PenFed. They informed me that my NCUA coverage could be increased by naming POD beneficiaries, but they said the beneficiary must be an immediate family member. So, I put my brothers name on it. I asked if I could increase the insurance by putting my brothers kids as POD ben., and they said no.

Francis
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Postby dm200 » Sun Jan 10, 2010 10:48 am

I am not sure on the credit union insurance fund, but I do not believe it is as clear on FDIC. It is my understanding that in 1987 Congress passed a non-binding resolution about Federal backing but to date there is no law or statute that strictly binds Treasury to fund the FDIC. In fact, I think the laws that have been passed strictly allow the FDIC to borrow from the Treasury.


I believe the NCUA (credit union) federal insurance fund is just as solid (from a federal government backing) as the FDIC. Looking at the percentage of dollars in the fund, it is currently stronger than the FDIC.

The Federal Credit Union Act (as amended by Congress and signed by the President) says (in fact mandates the statement on the signs displayed in every federally insured credit union) that insured shares are backed by the full faith and credit of the US Government. I suggest you read the Federal Credit Union act before you spout off about this.
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Postby dm200 » Sun Jan 10, 2010 10:51 am

fsrph wrote:
joe8d wrote:
1. For large amounts being invested, you run into the Federal Insurance limit of $250,000.


You can increased the FDIC coverage by adding POD beneficiaries to your accounts.The coverage is increased by a multiple of the number of the beneficiaries you list.I'm doing that myself.


I wonder if I was told the correct info from PenFed. They informed me that my NCUA coverage could be increased by naming POD beneficiaries, but they said the beneficiary must be an immediate family member. So, I put my brothers name on it. I asked if I could increase the insurance by putting my brothers kids as POD ben., and they said no.

Francis


When did Pentagon Federal give you that information? There were restrictions on NCUA insurance coverage (as well as FDIC coverage for banks) based on the relationship of the POD beneficiary. Those restrictions were relaxed over a year ago. It sounds like PenFed may have given the correct iformation at the time, but the rules changed after that.
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Postby dm200 » Sun Jan 10, 2010 10:53 am

joe8d wrote:
1. For large amounts being invested, you run into the Federal Insurance limit of $250,000.


You can increased the FDIC coverage by adding POD beneficiaries to your accounts.The coverage is increased by a multiple of the number of the beneficiaries you list.I'm doing that myself.


Fir individuals, this is certainly true. However, for organizations, companies, etc., this is not an option to increase federal insurance beyind the $250,000. For such entities, often having larger balances than individuals, Treasuries could make more sense.
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Postby fsrph » Sun Jan 10, 2010 10:56 am

dm200 wrote:
fsrph wrote:
joe8d wrote:
1. For large amounts being invested, you run into the Federal Insurance limit of $250,000.


You can increased the FDIC coverage by adding POD beneficiaries to your accounts.The coverage is increased by a multiple of the number of the beneficiaries you list.I'm doing that myself.


I wonder if I was told the correct info from PenFed. They informed me that my NCUA coverage could be increased by naming POD beneficiaries, but they said the beneficiary must be an immediate family member. So, I put my brothers name on it. I asked if I could increase the insurance by putting my brothers kids as POD ben., and they said no.

Francis


When did Pentagon Federal give you that information? There were restrictions on NCUA insurance coverage (as well as FDIC coverage for banks) based on the relationship of the POD beneficiary. Those restrictions were relaxed over a year ago. It sounds like PenFed may have given the correct iformation at the time, but the rules changed after that.


They gave me that info in the beginning of this month, Jan 2010. I opened another CD with them and called them with this very question - POD beneficiaries. I ended up just putting my brothers name as the POD-ben, but what I ws trying to do is figure out how much I can move to PenFed and still be covered by NCUA insurance. I still don't know that answer.

Francis
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Postby dm200 » Sun Jan 10, 2010 11:01 am

musbane wrote:As far as the put aspect is concerned - from my own work recently in setting up several 5 year CDs as well as reading and contributing to several CD threads, it is clear that some providers will not let you cancell unless they want to. Others spell out the penalties if you do cancell, but don't say up front in writing that cancellation is your unilateral right. This group will verbally say it is, but a carefull person must imagine that if/when one wants to cancell, it is likely that thousands of others will also. And that that will be precisely when the bank will really, really rather you didn't. And will be looking closely at their contract.


Your contractual rights would be spelled out in the Truth In Savings disclosure that must be provided by the issuing bank or credit union. Read it ALL. If it doesn't say you can withdraw early with a penalty, then you do not have that right. I would not depend on what a rep told me verbally, not on a general statement on a web site. What you need to see is the actual "disclosure". Here is one from navy Federal Credit Union
http://www.navyfederal.org/about/public ... U_602E.pdf

The first few pages are the application. pages 4 and 5 are the actual "disclosures". What you read and should get is a dicument that looks something like this. Another document that sometimes is together with the disclosure is the "Rate and Fee" schedule.
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Postby FrankM » Sun Jan 10, 2010 11:39 am

One key difference that has not been mentioned is State Taxation.
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Postby dbr » Sun Jan 10, 2010 11:46 am

FrankM wrote:One key difference that has not been mentioned is State Taxation.


It is interesting that lists of tax efficiency of investments frequently neglect to note the state tax exemption of treasury instruments and of some agency instruments.
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Postby MCSquared » Sun Jan 10, 2010 11:56 am

dm200 wrote:
I am not sure on the credit union insurance fund, but I do not believe it is as clear on FDIC. It is my understanding that in 1987 Congress passed a non-binding resolution about Federal backing but to date there is no law or statute that strictly binds Treasury to fund the FDIC. In fact, I think the laws that have been passed strictly allow the FDIC to borrow from the Treasury.


I believe the NCUA (credit union) federal insurance fund is just as solid (from a federal government backing) as the FDIC. Looking at the percentage of dollars in the fund, it is currently stronger than the FDIC.

The Federal Credit Union Act (as amended by Congress and signed by the President) says (in fact mandates the statement on the signs displayed in every federally insured credit union) that insured shares are backed by the full faith and credit of the US Government. I suggest you read the Federal Credit Union act before you spout off about this.


What are you referring to? I specifically said that I was not sure about the credit unions (I have never read or researched anything on them as I do not use any nor do I intend to). My post was about FDIC insurance and the fact that I know of no law or statute that specifically binds the Treasury to fund the FDIC. Maybe you do know of a law or statute and can share that information. From what I have read, the FDIC can BORROW from the Treasury. Maybe you should read my post again "before you spout off about this."
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Postby Doc » Sun Jan 10, 2010 1:10 pm

dbr wrote:
FrankM wrote:One key difference that has not been mentioned is State Taxation.


It is interesting that lists of tax efficiency of investments frequently neglect to note the state tax exemption of treasury instruments and of some agency instruments.


I think the reason is that Morningstar and other similar sources, even fund companies themselves, list their "after tax" numbers at the highest Federal rate. Interesting I just looked up M*'s "definition" and found:

Tax-adjusted Return
Tax-adjusted returns and tax cost ratio are estimates of the impact taxes have had on a fund. We assume the highest tax rate in calculating these figures. These returns follow the SEC guidelines for calculating returns before sale of shares.

SEC
, who would have thought?

In any case this restriction on how to report the tax effects, really only applies to the top 1% or so of investors and can lead to erroneous results for the rest of us.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby LadyGeek » Sun Jan 10, 2010 1:40 pm

linuxizer wrote:Also, I have long been curious about the historical market rate differences between the CD and Treasury yield curves. Treasury's easier to find, but CDs much less so (not least because there's no one rate for CDs, only an average and a min/max). Does anyone have that info?
The St. Louis Fed has reference info (links provided by Barry Barnitz). However, I don't know what data to plot. Can someone point out which curves should be used to plot treasury and CD rates over time? Note that the CDs are for secondary market.

Please see the CDs vs Bonds discussion page on the Bogleheads Wiki for the data series.

Tip- The bottom of every wiki page (but not the discussion pages) has text you can copy and paste back into your forum post so the link looks like this: Please see CDs vs Bonds on the Bogleheads Wiki.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby MCSquared » Sun Jan 10, 2010 3:13 pm

linuxizer wrote:Hi folks,

I have briefly attempted to summarize some of the key differences and similarities between CDs and Treasuries, as well as how those differences play out in portfolio construction.

While CDs are often thought of as different assets than bonds, in reality they are simply bonds with special characteristics. These differences and similarities will be explored below.

Because CDs, like U.S. Treasuries, are backed by the full-faith and credit of the U.S. Government, Treasury Bonds are the appropriate comparison. Furthermore, because there is no functional difference in the behavior of a rolling bond ladder and a bond fund,in the interests of brevity, in the interests of brevity, the term "bond" on this page can be taken to mean U.S. Treasury bonds or Treasury bond fund.

Characteristics and Risks

In general, assuming yields are equal, CDs are preferred to bonds in rising-interest-rate environments, whereas Treasuries are preferred to CDs in falling-rate environments.

* Liquidity - Treasuries are the most liquid bond market in the world. CDs, by contrast, cannot typically be traded; even brokered CDs have fairly high spreads. In a rising rate environment, this lack of liquidity is not a problem if the CD has a put option (see below). In a falling rate environment, however, liquidating the bond for purposes such as rebalancing, tax management, or funding unexpected life events, becomes costly (at risk is exactly equivalent to the increase in market value of a bond in a falling rate environment).

* Options - Many CDs have a put option which allows the bondholder to receive the premium back from the bank in exchange for a penalty (typically 3-6 months of coupon payments). In a rising rate environment this can be a valuable feature of CDs. Treasuries no longer have embedded call options, and CDs do not have call options. However, CDs are subject to a certain type of call risk--the risk that if a bank goes under, the FDIC will not continue to honor the terms of the original bond agreements. The amount at risk is exactly equivalent to the increase in market value of a bond in a falling rate environment.

* Purchasing convenience - Some individuals prefer dealing directly with their local bank; others prefer dealing with a broker of their choice.

* Credit risk - Both CDs and Treasuries are obligations of the U.S. Government, and are therefore considered to have no credit risk. CDs must remain under certain purchase limits to maintain this feature.

Market history

Because CDs cater primarily to the individual investor market, whereas Treasuries can be traded in large volumes by institutional investors as well, and because the characteristics of the bonds differ (particularly with regards to liquidity and options), yields on Treasuries and on CDs are never exactly alike.


This is a very lazy first stab at things, and I am sure I have missed key points, as well as thoroughly offended one camp or another ;-). Let's discuss this here, and then I or someone else can update the wiki ( http://www.bogleheads.org/wiki/CDs_vs_Bonds ) with our findings.

Also, I have long been curious about the historical market rate differences between the CD and Treasury yield curves. Treasury's easier to find, but CDs much less so (not least because there's no one rate for CDs, only an average and a min/max). Does anyone have that info?


Linux:

I do not have the information you referenced but I think a closer comparison would be CD's and FDIC guaranteed bank debt. These bonds trade at a spread over Treasuries. I seem to recall Goldman issuing $5 billion or so of this debt a year or so ago and they traded at roughly 200 basis points over Treasuries. Today, I think those spreads have shrunk to 25-50 basis points. These were bonds issued with the explicit guarantee of the FDIC as opposed to some implied guarantee. Just my opinion obviously, but I think it has something to do with that "no free lunch".... :)
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby LadyGeek » Sun Jan 10, 2010 11:32 pm

MCSquared wrote:Linux:

I do not have the information you referenced but I think a closer comparison would be CD's and FDIC guaranteed bank debt. These bonds trade at a spread over Treasuries. I seem to recall Goldman issuing $5 billion or so of this debt a year or so ago and they traded at roughly 200 basis points over Treasuries. Today, I think those spreads have shrunk to 25-50 basis points. These were bonds issued with the explicit guarantee of the FDIC as opposed to some implied guarantee. Just my opinion obviously, but I think it has something to do with that "no free lunch".... :)
Out of curiousity, I downloaded the historical data from the St. Louis Fed and ran a comparison plot of 6 month CD's vs. 6 month Treasury Bills. I don't have the background to interpret these plots. If the charts don't apply, it's not a problem to remove them.

Can you point to a data source (Excel preferred) for the FDIC guaranteed bank debt? I tried the FDIC and found lots of bank statistics, but nothing called a guaranteed bank debt: FDIC Research and Analysis. Be sure to enable cookies.

Please see CDs vs Bonds on the Bogleheads Wiki. Also, the CDs vs Bonds discussion page.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby MCSquared » Mon Jan 11, 2010 1:06 am

LadyGeek wrote:
MCSquared wrote:Linux:

I do not have the information you referenced but I think a closer comparison would be CD's and FDIC guaranteed bank debt. These bonds trade at a spread over Treasuries. I seem to recall Goldman issuing $5 billion or so of this debt a year or so ago and they traded at roughly 200 basis points over Treasuries. Today, I think those spreads have shrunk to 25-50 basis points. These were bonds issued with the explicit guarantee of the FDIC as opposed to some implied guarantee. Just my opinion obviously, but I think it has something to do with that "no free lunch".... :)
Out of curiousity, I downloaded the historical data from the St. Louis Fed and ran a comparison plot of 6 month CD's vs. 6 month Treasury Bills. I don't have the background to interpret these plots. If the charts don't apply, it's not a problem to remove them.

Can you point to a data source (Excel preferred) for the FDIC guaranteed bank debt? I tried the FDIC and found lots of bank statistics, but nothing called a guaranteed bank debt: FDIC Research and Analysis. Be sure to enable cookies.

Please see CDs vs Bonds on the Bogleheads Wiki. Also, the CDs vs Bonds discussion page.


The debt I am referring to is part of the FDIC Temporary Liquidity Guarantee Program. In essence, I believe the FDIC agreed to guarantee newly issued senior debt of any qualified member institution through 2012. There were a handful of companies who issued debt under this program but I am not sure how one can track these bonds. The spread over treasuries that the Goldman issue received was widely reported (200 bips) so I think a google search would yield some results. I looked at spreads a week ago when I purchased a Treasury Bond and I noticed that the spread on a FDIC guaranteed Wells Fargo bond was trading at roughly 30 or so bips over the corresponding Treasury so spreads have obviously tightened considerably. It should not matter much who the issuer is/was as they all received AAA rating due to the explicit FDIC guarantee.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby tfb » Mon Jan 11, 2010 12:08 pm

LadyGeek wrote:Out of curiousity, I downloaded the historical data from the St. Louis Fed and ran a comparison plot of 6 month CD's vs. 6 month Treasury Bills. I don't have the background to interpret these plots. If the charts don't apply, it's not a problem to remove them.

I think a chart showing the difference between two rates will be more helpful. The current charts are hard to tell what the difference really was.
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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby Barry Barnitz » Mon Jan 11, 2010 12:22 pm

tfb wrote:
LadyGeek wrote:Out of curiousity, I downloaded the historical data from the St. Louis Fed and ran a comparison plot of 6 month CD's vs. 6 month Treasury Bills. I don't have the background to interpret these plots. If the charts don't apply, it's not a problem to remove them.

I think a chart showing the difference between two rates will be more helpful. The current charts are hard to tell what the difference really was.


I downloaded the monthly series (from June 1964 to December 2009) and took the arithmetic average of the two series. The results:
Code: Select all

The average cd rate = 6.44

The average tbill rate= 5.71

Difference = 0.73

Percentage difference= 11.27%


For me personally, slightly more than one half of the cd rate advantage is due to the tax factor (state taxation of cd interest, no itemized deduction)

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Re: Treasuries vs. CDs: Differences, similarities, and portf

Postby mas » Mon Jan 11, 2010 4:29 pm

tfb wrote:
LadyGeek wrote:Out of curiousity, I downloaded the historical data from the St. Louis Fed and ran a comparison plot of 6 month CD's vs. 6 month Treasury Bills. I don't have the background to interpret these plots. If the charts don't apply, it's not a problem to remove them.

I think a chart showing the difference between two rates will be more helpful. The current charts are hard to tell what the difference really was.

I agree. I took a quick stab at it:

Image

Some aggregate stats:
Min=-0.09%
Max=4.88%
Mean=0.72%
Median=0.54%

Only 11 out of 10083 days had a negative premium (i.e. TBill yielding more than CD).

Edit: The graph and the values above should be *100 and labelled basis points. They are simply the arithmetic difference of the yields.
Last edited by mas on Tue Jan 12, 2010 11:48 am, edited 1 time in total.
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Postby linuxizer » Mon Jan 11, 2010 5:59 pm

Fascinating. Thanks to all those who have done the research/graphing so far. I was expecting it to be a little more balanced in terms of when Treasuries offered better yields, particularly since many of the options on CDs are fairly valuable (particularly the put). It's hard to tell how much is a liquidity premium and how much is a consequence of the differing markets (institutional vs. individual) and the time spent rate chasing with CDs.

Apropos, how easy is it to hold CDs in an IRA?
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Postby dm200 » Mon Jan 11, 2010 7:12 pm

linuxizer wrote:Apropos, how easy is it to hold CDs in an IRA?


VERY easy. Establish an IRA at a credit union, for example. Then purchase CDs (usually called share certificates) in the IRA. As long as the CDs (or certificates) under the umbrella of the IRA, you should be able to move money into and out of the CDs.

Where it gets more complicated (perhaps too complicated) is having CDs at a lot of different institutions.
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Postby Bob's not my name » Mon Jan 11, 2010 9:08 pm

Very easy to hold brokered CDs in a Vanguard IRA.
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Postby LadyGeek » Mon Jan 11, 2010 9:11 pm

What's important here- the absolute value of the interest, the tracking between CDs and bonds, or the shape of the curve?

I plotted the 3 month CD vs. T-bill rates over time (DCD90.xls, DTB3.xls) and it looked darn near identical to the 6 month plots. Maybe a tiny bit lower in interest rate, if at all. (Works fine in Open Office.)

It seems that if you factor in state taxes, you should use the historical rates in effect at that time, e.g. VA state tax in 1964.

One other point - A few tenths movement in interest rate when rates are low looks large in terms of percentage, e.g. (1.5% +/- .1%) is a greater percentage change than (4.5% +/- .1 %). If conclusions are going to made about CDs vs. bonds going forward, I think that needs to be factored in the discussion somehow.

(My spouse had an IRA CD with his credit union. It was transferred into a VG target retirement fund at maturity.)
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CD Yield Premium

Postby Barry Barnitz » Mon Jan 11, 2010 9:51 pm

Hi:

One other potential consideration here might be the presence of a default risk premium. I have not checked, but the fed data may reflect institutional CD's that are bought by money market funds and other institutional money market investors, These CD's, naturally, do not come under the shield of FDIC deposit insurance.

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Postby LadyGeek » Mon Jan 11, 2010 11:09 pm

The best I could find on secondary market (I'm way out of my league here) is a paper written by the St. Louis Fed: Can Feedback from the Jumbo-CD Market Improve Off-Site Surveillance of Community Banks?

Section 2 and 3 might be relevant, as well as Table 4a. They discuss premiums and residuals. Granted that this is related to off-site surveillance, but maybe it could shed some light on how the fed defines "secondary market".

I did a google search for "secondary market definition site:www.stlouisfed.org". The info comes from the St. Louis fed directly, so it is an authoritative source.

All of this is to understand if those CD rates are valid to compare with T-bills.
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Postby Bob's not my name » Tue Jan 12, 2010 8:28 am

Anecdotal evidence does not disprove a data set, but in my experience I've been able to get 6-month CDs at higher rates than the data set indicates. For example, in May 2009 I got a 6-month CD paying 2%, whereas the data set shows an average of about 0.5%.

I have no experience with direct investing in Treasuries. On the CD side, I believe the individual investor can do best by having accounts at one or two credit unions and a brokerage account with low trade fees (at Vanguard you can buy new CD issues with no fee). In my experience the credit unions' offerings are always better than brokered CDs for short terms (<2 years), but you can often do better with brokered CDs for longer terms.

For 1-year T-bills, the St Louis Fed Reserve site shows interest rates dropping to 0.5% in late 2008. At that time I was buying 1-year CDs paying 3.6%. I think this was just lucky -- the credit union was slow to respond to falling rates.
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Postby mas » Tue Jan 12, 2010 11:59 am

The federal reserve describes the CD rates in their data set.
http://www.federalreserve.gov/releases/ ... _CD_M6.txt:
* Average rate on 6-month neogtiable certificates of deposit (secondary market), quoted on an investment basis
* Annualized using a 360-day year or bank interest."
* An average of dealer bid rates on nationally traded certificates of deposit.

So they are an average (not the high).
They are based on the bid price. This explains the high peaks, where liquidity dried up and nobody was willing to bid (as compared to highly liquid treasuries). Using the bid might also make the yield slightly higher than you could actually purchase them for (again some liquidity premium).
This data set also doesn't necessarily represent the rates for direct purchased CDs.
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Postby LadyGeek » Tue Jan 12, 2010 9:26 pm

Slight typo on your link: http://www.federalreserve.gov/releases/ ... _CD_M6.txt

As for the T-bills, go up a few directory levels and take a look at the footnotes of H.15 Selected Interest Rates (daily). Lots of links there.

For example, Commercial paper (hit "About" to get a definition of commercial paper)

I think what you're looking for is at US Treasury: Daily Treasury Yield Curve Rates. There's even a detailed description of the Treasury Yield Curve Methodology.
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Postby linuxizer » Tue Jan 12, 2010 10:35 pm

I'm a little worried about the representativeness (since most Bogleheads are probably buying from PenFed and other market-toppers rather than the corner brick-and-mortar bank), but very worried about the yield curves diverging. The options and liquidity differences become much bigger as the maturity increases. I believe it was Barry who pointed out that no one's going to trade in a 6-month CD if rates rise, since there's a 3-month penalty!
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Postby LadyGeek » Wed Jan 20, 2010 9:10 pm

I just did some editing to CDs vs Bonds on the Bogleheads Wiki. I'm not sure if this statement is correct about options (middle of the paragraph):
wiki wrote:Treasuries no longer have embedded call options[2] and CDs do not have call options, so if interest rates decline the investor can continue to hold the higher yielding note or CD to maturity.

Callable CDs do exist. Should I modify the text to say:
Treasuries no longer have embedded call options[2] and most CDs do not have call options, so if interest rates decline the investor can continue to hold the higher yielding note or CD to maturity.

I want to make sure that I don't mis-state the intent here. Is this correction OK?

I also removed the comments about the market history graphs (to check source, etc.). Comments/ questions welcome. Wiki editors feel free to update directly.
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Postby linuxizer » Wed Jan 20, 2010 9:13 pm

Callable CDs do exist (but they're not that common). Your modification sounds like a big improvement.

Thanks!
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Postby LadyGeek » Wed Jan 20, 2010 9:19 pm

Done. Please see CDs vs Bonds on the Bogleheads Wiki.
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