Nature and characteristics of fixed deposits?

Answer 1

Depository institution (such as a bank, credit union, or a finance or insurance company) account that pays higher than savings account interest rates but imposes conditions on the amount , frequency , and/or period of withdrawals with the understanding that the customer can withdraw only by giving advanced notice. A certificate of deposit (CD) is normally issued for fixed deposits. A Fixed Deposit, also called Term Deposit, is an investment route that provides a regular stream of income for investors, very appealing to conservative, low-risk investors. Fixed deposits involve investing a particular sum of money with a bank or a financial institution or even a company; this investment is in the form of debt. There is a particular rate of interest that is paid on these fixed deposits for a specified period of time. At the end of the specified time period, the interest payment ceases and the original amount that is invested is returned to the investor. Looking at the nature of the investment, this is a route that is suitable for all those who prefer keeping their investments safe and secure. The other reason for selecting a fixed deposit over other investment routes is to generate a regular income from the investment, which provides an element of stability to the money invested. There are several features of a fixed deposit that set it apart from various other investment options present in the market. These features determine the nature of the entire investment and how it will behave under different circumstances. Here are important features that need attention: 1. Debt investment A fixed deposit is a debt investment. This means the amount is invested with the feature considering that this will be returned to the investor once the specified time period is over. This is different from an equity investment where there is a chance of a risk with regard to the amount invested because the investor becomes the owner of the company. In case of a fixed deposit, the investor is only lending the money to the bank or the institution. 2. Lender The investor who buys a fixed deposit takes on the role of a lender in the entire transaction. In this case, the bank or financial institution taking the money is the borrower. Once the position of the lender is established, it means that the bank has to pay back the amount that has been borrowed from the investor. In that sense there is a responsibility of the bank to return the money to the investor. This also impacts the feature of the investment, which underlines that there is meant to be safety of the capital invested unlike an equity investment where even this might be lost. 3. Specified interest There is a return that is earned by the investor when he/she gives a fixed deposit to the bank. The return here is measured by using the term 'interest'. Interest is nothing but the amount calculated at a specified rate of return on the amount invested. There is an element of surety for the investor because the person knows the interest rate at the time of making the deposit itself and due to this reason he/she also knows the amount of money that will be earned from the investment. The important thing is that even if economic conditions are very good or very bad the investor will keep earning the same rate of interest, so this becomes like a fixed figure that is earned by the investor. 4. Time of repayment Another important feature of the fixed deposit is that the investment is for a specified period of time that is already known to the investor at the time of making the investment. At the end of the specified period, the investment will come to an end and the amount will be returned to the investor. This means that the investor knows the return for the specified time and hence he/she is able to know precisely what he/she is earning and also how the cash flow will be present in the future. Investing in a fixed deposit There are several options available when it comes to where to make a fixed deposit. One of the most common areas where a fixed deposit is offered is the banks. All types of banks, be they public sector or private sector or even co-operative banks, offer fixed deposits for their customers. This makes fixed deposits one of the most accessible options for investors because of the fact that most people have a bank account at some place or the other. The second option for investing in a fixed deposit is with a financial institution. There are several institutions that offer a deposit option. This can include housing finance institutions or even other lending institutions that offer deposits as a means of raising funds for their activities. It can also include various non-banking finance companies that are trying to raise funds through the route of deposits so that they can tap a larger investor base for their fund requirements. There is one more area where fixed deposits are offered; these are the companies that seek to raise funds through this route. Various companies from the manufacturing to the service sector need funds for financing their various activities and they raise money through the route of company fixed deposits. The features of all these deposits are the same; the only difference is being the entity that is issuing the deposit, so there will be a difference in the risk element for the investor in these deposits. Risk element in a fixed deposit Most people believe that because a particular investment is in a debt instrument there is no risk involved in the entire process. This is not true because every investment involves some kind of risk. In the case of fixed deposits, the risk is in the form of credit risk which arises when the institution that has borrowed the money is not being able to repay the amount because of its poor financial position. The risk element for various types of institutions is different. In case of banks, there can be a situation where a bank becomes insolvent and hence cannot repay the deposits. The amount recovered will depend upon the individual position of the bank involved. In case of other financial institutions as well as companies, there is also the same risk that the interest and the capital amount will not be repaid because of the poor financial condition of the borrower. In this situation, there is little that the investor can do because there is no guarantee present from any source and the loss, if any, will have to be completely borne by the investor. There have been several such cases of defaults by companies in the past. Hope that this answers your question. Regards, J.J.