Primary vs. Secondary Certificates of Deposit

A certificate of deposit (CD) is obtained in either the primary or secondary market. In the primary market, a CD is obtained directly from the creator of the CD, typically a bank, by making a deposit. In the secondary market, a CD is bought or sold, usually through a brokerage firm, for a price either above or below the original deposit.The primary market offers stability.The secondary market offers flexibility.

A certificate of deposit acts like a savings account. Both earn interest and are insured by the Federal Deposit Insurance Corporation (FDIC), if the bank is a member. However, it is not as easy to withdraw funds from a CD compared to a savings account. Instead, a deposit is returned in full after a specific amount of time known as maturity date. Maturities can range from months to years. In exchange for the longer maturity, a CD pays more interest than a savings account.

Banks derive business from saving and CD accounts when they use these deposits to make loans. As a result, banks offer a variety of deposit accounts but few other investments. Another consideration is that penalties are charged for withdrawing funds before maturity. Further, a matured CD often is automatically rolled into a new CD. If interest rates have fallen, the new CD pays less. Since banks primarily offer deposit accounts, few higher-paying investments are available.

Brokerage firms derive business from an array of financial investments traded on secondary markets. A CD purchased from a broker can be sold prior to maturity without penalty. Also, if an existing CD has a higher interest rate than a new CD, it can be sold for more than the initial deposit. On the flip side, if a CD has a lower rate, it could be sold for only pennies. Further, a CD purchased from a brokerage firm does not automatically roll over and other investment choices are available at maturity.

Secondary markets are often referred to as resale markets. Resale markets exist for most items. Stocks are resold on the New York Stock Exchange. CDs are resold on the "over-the-counter" market. The key to understanding secondary markets is to understand how items are priced. To illustrate, compare a five year CD purchased four years ago paying 5 percent with a new issue one year CD paying only 3 percent. The 5 percent CD would be worth $20 more than the 3 percent CD. The worth is the difference in annual interest earned by each CD, $50 for the 5 percent CD and $30 for the 3 percent. Other factors that affect the variation of price include popularity, maturity and interest rates paid on similar investments.

Banks post interest rates as they issue new certificates of deposit. A good source to find the highest rates is the finance section of a newspaper or at bankrate.com. Brokerage firms can quote you prices on previously issued CDs for a variety of interest rates.