Answers about Index-linked Certificates of Deposit

How do I earn interest on an index-linked Certificate of Deposit (CD)?

The interest on an index-linked CD is tied to an index selected by the bank, such as the S&P 500, LIBOR or the Russell 2000. Depending upon how the CD is structured, the investor may earn interest if the index changes.  Some CDs pay interest based on an increase in an index; some pay interest based on a decrease in an index.  Some CDs pay interest if an index stays within a certain range, but they pay no interest if the index moves out of that range. In addition, some CDs average changes in the index quarterly or annually during the term of the CD.  This may produce a different result than a formula that focuses upon index results as of specific dates (e.g., 3/31 or 12/31).

The interest on the CD may be subject to a cap or a participation rate. A participation rate determines how much of the index's change will be used to compute the interest. For example, if the index goes up 10% and the participation rate is 80%, the investor will receive 8% interest over the term of the CD.  If the index goes down, the investor could earn zero percent interest over the term of the CD. Customers should look at APY disclosures when comparing products. 

March 2010