Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 16:  Fixed-term and instant-access deposit accounts  Certificates of Deposit 16cis

Fixed and instant access deposit accounts Banks make money by borrowing money from depositors and lending the money out again at a higher rate of interest  Banks need to match the maturities of their assets (the loans they have made to borrowers) and their liabilities (the deposits they have accepted from borrowers)  Loans tend to be for periods of years  Deposits can be withdrawn at any time Banks will pay a higher rate of interest to savers who are prepared to tie up their money for longer periods of time  The larger the amount and the longer the term, the higher the interest rate

Savings products: fixed rate “bonds” A guaranteed amount of interest for a set length of time with little or no access to funds.  Typical features of such “bonds” include:  Account is protected by the UK FSCS  Interest is paid upon maturity of the bond  No withdrawals  No early closure permitted during the term  No additional deposits permitted during the term Rates quoted 4 th August 2010 Source: MoneySupermarket.com

Savings products: instant access Everyday accounts that usually allow you to dip in and out of your savings without loss of interest.  Instant access accounts include some or all of these features:  Account is protected by the UK FSCS  Unlimited withdrawals without penalties  Unlimited deposits  Interest rate guaranteed for 12 months  Choose from monthly or annual interest Rates quoted 4 th August 2010 Source: MoneySupermarket.com

Supermarket banks Supermarkets like Sainsbury’s and Tesco offer savings accounts  They often offer shopping-related deals to their depositors  These deals are frequently tied into their loyalty cards

Such deals come with strings attached… If you’re a regular shopper at Sainsbury’s the chance to earn double Nectar points for two years will be appealing and, coupled with a competitive rate of interest, this account may seem ideal. However, there are some catches to be aware of. The double Nectar points offer is conditional on you maintaining a balance of at least £5,000 for two years. This is more than many people keep in their instant access account. What’s more, while the initial rate of 2.70% is good, it includes a 12-month bonus. After the first year it drops to the standard Easy Saver rate which is much less competitive – currently 0.50%. But you’ll have to keep your money invested for another 12 months if you are to qualify for double Nectar points. The other things to note about this account are that a maximum of five withdrawals are allowed during the first year. And the rate of 2.70% only applies on balances up to £100,000. If you make more than five withdrawals or your balance exceeds £100,000 you will earn the standard rate of 0.50%. There are a number of other easy access accounts paying 2.70% or higher which have fewer catches so it really depends on how much you value the opportunity to earn double Nectar points.

How much you value the opportunity to earn double Nectar points? Q: How much are Nectar Points worth? A: For every 500 points you get £2.50 off your next shopping visit to Sainsbury’s. So one Nectar point is worth ½p to the saver. The saver’s 33,280 Nectar Points are worth 16,640p, which is £ worth of Sainsbury’s shopping Q: What is the cost of an average weekly shop at Sainsbury’s? A: A poll by Netmums four years ago revealed that 56% of respondents spent £ on their weekly shop. WhatPrice? website did a weekly shop for two adults and two children and found the average price was £ Let’s assume £80 for our weekly shop Q: For an average Sainsbury’s shopper, how many Nectar points will be earned, as a result of the double Nectar Points over the life of the two-year deal? A: Two years = 104 weeks; 104 x £80 = £8,320; £8,320 x 4 = 33,280 Nectar Points Q: How many Nectar Points are earned with the average weekly shop at Sainsbury’s? A: A points calculator on the Nectar web-site indicates that Sainsbury’s award two Nectar Points for every £1 spent in store. Double Nectar Points means 4 for every £1 spent. Q: What is the value of the double Nectar Points in terms of return on cash deposited? A: The saver has deposited £5,000 for two years; £ is the equivalent of an additional return of 1.67% per annum, giving an overall rate on the deposit of 4.4% p.a.

Is the Sainsbury’s account a good deal? To achieve a return of 4.4%, the Sainsbury's Finance Easy Saver customer has to keep a minimum of £5,000 deposited in the account for two years  This account has the characteristics of a fixed rate “bond” account  It is fairer to compare the Sainsbury account offer with a similar fixed rate bond offered in the market When compared with a fixed-rate bond deal, the Sainsbury’s offer does not look all that compelling…

What does this deal cost Sainsbury’s? What does the Nectar Points offer cost Sainsbury’s? 1.67% of the interest is not paid in cash but in the form of 33,280 Nectar Points, which Sainsbury’s “buys” from the Nectar organisation (owned by a Canadian company) How much does Sainsbury’s pay Nectar for the Nectar Points?  Sainsbury’s is prepared to redeem one Nectar Point for ½p (0.5p) worth of Sainsbury’s groceries  Sainsbury’s adds an average retail mark-up of around 6% on everything it sells o So the actual cost to Sainsbury’s is probably around 0.47p for every Nectar Point redeemed in its stores (0.5 less 6% mark-up)  No business can afford to pay a wholesale price which is higher than the price it charges retail  So we can assume that Sainsbury’s “pays” the Nectar organisation much less than 0.47p per Nectar Point – probably around 0.15p It is possible that Sainsbury’s “pays” around 0.15p for the 33,280 Nectar Points, making £50 in total

Cash cost to Sainsbury’s of servicing the account Cash interest cost on £5,000 at 2.70% for two years:£270 Cash cost of the Nectar Points:£ Total cash cost to Sainsbury’s over two years:£320 Total cash cost per year:£160 Annual percentage cash pay-out on £5, % Now the Sainsbury’s Finance Easy Saver deal doesn’t look quite so generous…

But is that the end of the story? Nectar is a customer loyalty scheme. Although Nectar Points can be spent in many different outlets (TalkTalk, BP filling stations, etc), if you want to redeem them for groceries, you can only use them at Sainsbury’s  If the Sainsbury’s Finance Easy Saver account holder has managed to keep £5,000 in the account at all times for two years, he / she will probably end up with 33,280 Nectar Points  Assume that just half of all such account holders choose to redeem their Nectar Points at Sainsbury’s o i.e. for every Easy Saver account, on average 16,640 Nectar Points are redeemed at Sainsbury’s  The 16,640 Nectar Points will be redeemed for £83.20 of Sainsbury groceries (i.e. 16,640 x 0.5p)  That is the equivalent of one average weekly shop o It is likely the customer will use the “free” weekly shop as an opportunity to buy some luxury items without straining the household budget  Sainsbury’s can make double its usual margin on luxury items

Certificates of Deposit Certificates of Deposit (CDs) are half-way between a bond and a cash deposit CDs are issued by banks in return for deposited money  The deposit is for a specified period of time  Traditionally this is for a maximum of five years  The deposit is a fixed sum  The minimum deposit in the UK is £100,000  The interest rates can be fixed or variable Certificates of deposit (CDs) are negotiable : they can be bought and sold  Because there is a penalty for early redemption, the depositor is unlikely to take the money back from the bank  The depositor will sell the CD to another investor

Coupons on floating rate CDs are fixed semi-annually against a reference rate such as LIBOR.  CDs are quoted according to their yield, and are priced according to their yield-discounted cashflows. Certificates of Deposit The London Interbank Offered Rate (or LIBOR) is a daily reference rate based on the interest rates at which banks borrow unsecured funds from other banks in the London wholesale money market (or interbank market).