In today’s posting we discuss two money market instruments that are quite versatile and useful namely Negotiable Certificates of Deposits (NCD) and Bankers Acceptance (BAs). I was introduced to these instruments in 1998 through Intermarket Southampton Asset Management (ISAM) which was then part of the Intermarket Group. These two greatly assisted me in wealth creation. The first amounts that I raised out of these made the initial deposit for DentalCare Services’s start up in 2001. I invested a portion of my cash into these instruments gradually over time and they generated sufficient funds for me to start in business. My initial salary was thus multiplied to become my start up capital. I strongly recommend these as a starting point to conservative or unsure investors. They are fairly safe with good returns. For example if someone is still considering the stock exchange investments, they can build up their initial capital by investing the money on money market instruments like these two. They yield better returns that Treasury Bills.
Negotiable Certificates of Deposits
A negotiable certificate of deposit (NCD) is a time deposit with a bank. Simply NCDs are certificates written by financial institutions as proof of deposit taken from a client. NCDs are issued by commercial banks but they can be bought through brokers and asset managers. They bear a specific maturity date (from three months to five years), a specified interest rate, and can be issued in any denomination. These funds cannot be withdrawn on demand but on maturity. NCDs offer a slightly higher yield than T-Bills because of the slightly higher default risk for a bank but, overall, the likelihood that a large bank will go broke is pretty slim. When you buy NCDs through a broker it is important to inquire who the issuing ban is. In 2003 we had invested in NCDs through National Discount House when it was closed down in September 2004 we lost some funds and these were later commuted to stocks in the unlisted entity.
Their attractiveness depends on the rating of the financial institution and the size of the deposit. Of course, the amount of interest you earn depends on a number of other factors such as the current interest rate environment, how much money you invest, the length of time and the particular bank you choose. It should be noted that sometimes banks which are in trouble tend to issue high paying NCDs as a way of enticing deposits. So when a single bank is offering rates which are too high when compared with others be careful as this may be an indicator that the bank is in trouble and therefore its riskier to deposit your funds with them.
While nearly every bank offers NCDs, the rates are rarely competitive, so it’s important to shop around. A fundamental concept to understand when buying a NCD is the difference between annual percentage yield (APY) and annual percentage rate (APR). APY is the total amount of interest you earn in one year, taking compound interest into account. APR is simply the stated interest you earn in one year, without taking compounding into account. The difference results from when interest is paid. The more frequently interest is calculated, the greater the yield will be. When an investment pays interest annually, its rate and yield are the same. In Zimbabwe generally banks offer annualized rates but one can increase these by ensuring that the funds are set for a certain period of time and then reinvested including the interest at maturity. This enables compound interest to work for you.
The main advantage of NCDs is their relative safety and the ability to know your return ahead of time. You’ll generally earn more than in a savings account, and you won’t be at the mercy of the stock market. NCDs are tradable in the secondary market. They can be used as security for borrowings.
Despite the benefits, there are two main disadvantages to CDs. First of all, the returns are paltry compared to many other investments. Furthermore, your money is tied up for the length of the NCD and you won’t be able to get it out without paying a harsh penalty.
It is a bill of exchange drawn on and accepted by a bank as a potential or contingent liability.
Created primarily to evade technical, practical and credibility problems that arose due to physical distance between buyers and sellers.
A bankers’ acceptance (BA) is a short-term credit investment created by a non-financial firm and guaranteed by a bank to make payment. The bank accepts the ultimate responsibility to pay its holder. Acceptances are traded at discounts from face value in the secondary market. For corporations, a BA acts as a negotiable time draft for financing imports, exports or other transactions in goods. This is especially useful when the creditworthiness of a foreign trade partner is unknown.
Some will remember in the 1990s when United Merchant Bank unscrupulously abused the sale of GMB Bills to raise more funds than the amount needed by GMB. It is critical to check on the credibility of the corporate raising the funds and the bank issuing the NCDs. United Merchant Bank then failed to make good on its guarantee and people lost money. This emphasizes the need for due diligence on any investment plan.
These two instruments are a better way to invest funds than to keep cash in a savings account. It is a way of maximizing returns on your cash position. They are critical to any investor so as to maintain a balance between being asset rich and cash rich. If one does not have readily available cash they end up with what is called a liquidity crisis – an inability to meet short term needs even though they are have enough assets.