The Behavior of FDIC-Insured
CDs in the Secondary Market

© 2003 by Werner Cohn

Brokered CDs have this in common with a Cadillacautomobile: the minute you've bought it, much of its market valueis gone, irretrievably. This loss is completely distinct fromany losses or gains that are due to interest-rate fluctuations.Here I present a method of estimating the magnitude of this (non-interest-related)loss at any one time.

To begin, here is a summary of findings fromdata available to me: while brokered-CDs (unlike their bank-boughtcousins) are touted as marketable at any time, their market valuesare in fact substantially below those to be expected from theprevailing interest rates at any given moment. Second, there isstrong evidence that CDs issued by lower-ranked banks suffer significantlysharper losses in the secondary market than issues from higher-rankedbanks.

There is a straightforward procedure of assessingthe magnitude of these non-interest effects: the widely availablealgorithm for finding the "price" of a bond. (See AppendixA for a description of the procedure). This "price"is the amount for which an older issue would sell if it were valuedaccording to currently operative interest rates; in other words,it is the price that an investor would pay to obtain an interestrate equal to that of an original-issue security of identicalcharacteristics. I will call it a correct price to distinguishit from the actual market value, the price at which thisolder issue actually brings on the secondary market. This actualprice is furnished by brokers to their customers on a regularbasis for each security that is held in a customer's portfolio.

Now the ratio between the actual and the correct,the A/C ratio, may be used as a measure of resale value of a bondor CD. As one would expect, Treasury issues have an A/C of justabout 1.00, but bank-issued CDs have A/Cs that are lower, sometimesmuch lower.

Unfortunately, the market-side data neededto perform the calculations of A/C ratios are not publicly availablein the case of brokered CDs. The secondary market in these securitiesis opaque; transactions are not reported in the press or anywhereelse. If you wish to sell your CD on this market, you call yourbroker, who calls "someone" but won't say whom, andthen comes back with a price for you. There are businesses thatprice these issues, i.e. give estimates of market value, but theydo not report these data to the public. Brokerage firms receivesuch estimates and use them to give market values in monthly statementsto their customers. In other words, an individual customer canknow the (estimated) market value of his CD at any one time, buthe does not know the value of other issues.

Since I own four different CD issues, and alsoa number of Treasury issues, I have been able to make a modestanalysis of the second-market behavior of these securities. (SeeTable I). But it is a very modest analysis. To make a more conclusivestudy, I would need a great deal more data. My brokerage firmhas these data, but it has steadfastly refused to divulge them,even during discovery proceedings in an NASD arbitration case.

Table I summarizes my results. Since financialmarkets fluctuate from day to day, these results can show onlya static snapshot of what is actually a dynamic movement of prices.The date chosen is November 7, 2003. There is no reason to supposethat this date was in any way atypical.

The last column, Resale Value, is the mostcrucial. It shows that these already-issued CDs all sell belowprices that initial-issue CDs would bring. This is in contrastto the Treasury issue shown in the table, which sells at justabout the price of an initial issue.

The first column in the table contains a briefdescription of each issue. (The second of these issues, a Treasurynote, is included for purposes of comparison and contrast to theCDs).

Bank ratings, column two, come from BauerFinancial.Bauer "recommends" banks of four or more stars. A five-starrating, the maximum, is here imputed for the Treasury issue.

Correct Price, column three, is computed asshown in Appendix A.

Actual Price, column four, was obtained frommy broker's statement, on line, dated November 7.

Current rates for Treasury Bills, Bonds, andNotes are listed in the financial pages of the New York Timesdaily.

Concluding Remarks

Unless they are held to maturity, brokered-CDshave the following disadvantages:

1. While a secondary market exists, it seemsto guarantee a loss to anyone who sells these instruments. Mybroker (Vanguard) did not disclose this feature when I boughtsuch issues.

2. The quality of the issuing bank is a crucialfactor in the secondary market of CDs. My broker neither disclosedthis fact to me, nor, by his own admission, considers it necessaryto inform his customers of the credit worthiness of the issuingbanks.

Finally, it may be asked why credit worthinessshould influence the market in government (FDIC) insured investments.Upon reflection, the answer is not difficult to fathom. FDIC insuranceis limited to $100,000 per investor at any one banking institution.But this is a paltry sum for the large investors who seem to dominatethe secondary market. For such players, these CDs are essentiallyuninsured instruments and are priced in accordance with the creditstanding of its issuers.

Werner Cohn
November 2003


Appendix A

"Bond price" is one of the built-infunctions in the HP-12C Financial Calculator, among other suchmachines. The owner's handbook for HP 12C, in turn, makes referenceto "Standard Securities Calculation Methods" by Spence,Graudenz, and Lynch.

The procedure uses the following parameters:

For any date D between date of issue and maturity:

I = prevailing yield to maturity on date D;that is to say, roughly, what a new security bought on this daywould yield. In effect, this value is an estimate of the new-issuevalue of a security on day D

PMT = coupon rate

D = current date

M = maturity date

With these four values plugged into the algorithm,the machine will yield "Price". This "price"must be understood to mean a theoretical price, that is the pricethe issue would bring if, and only if, only if, only interestrate fluctuations had effected the price. All prices are basedon a par value of 100.

An important ingredient in this calculationis a determination of the current interest rates of CDs, i.e.the "I". Such rates are not directly available because,unlike Treasury issues, there is no publicly available informationon interest rates applicable to CDs that mature throughout theyear. For that reason, I estimated these values as follows: Forany given CD, I determined its yield Y at day of its issue. Inext determined the yield X of a Treasury of identical maturitythat was sold at or close to the same date. I then multipliedthe ratio Y/X by the yield of a Treasury selling at date D.


A ten-year CD is purchased on January 15, 2003,maturing on January 15, 2013. It has a coupon rate of 4.15%, payablesemi-annually. On November 7, 2003, this kind of security, withthe same maturity date, would yield 4.35%. What "should"the original security bring on the secondary market ?

Here I=4.35, PMT=4.15%, D=November 7, 2003,and M=January 15, 2013. Plugging these values into the machineresulted in Price=98.49.



Table I

Relationship Between Bank Rating and Second-Market Performance,
Selected CD and Treasury Issues


 Bank Rating  Correct Price (C)  Actual Price A)  Resale Value
(A/C ratio)
10 years. 4.15%
 ***   96.87   94.90  0.980
 US Treas.
10 years. 3.625%
 (*****)   95.22   95.156  0.999
 Capital One
5 years, 5%
 ****  106.42  105.40  0.990
10 years, 4.1%
 ***   96.85   94.40  0.975
 Home Ln Indl
five years, 4.75%
 *** 1/2 106.08  104.50  0.985

All price values as of November 7, 2003

Correlations: Bank Rating vs. Resale Valuer=.999
CDs only, without Treasury, r=.944


BrokeredCDs: Caveat Emptor

Seniors are themost vulnerable


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