Insured Deposits

Both kinds of deposit trade some feature for safety: accounts you can withdraw from at any time trade yield for instant access, while CDs trade liquidity for a better rate. The rest of this lesson works through what the FDIC actually covers and where each deposit type sits on that trade-off.

What Makes a Deposit a Cash Equivalent?

Cash equivalents are short-term, highly liquid instruments readily convertible to known amounts of cash with minimal risk of price change. Insured bank deposits earn the highest safety ranking among them because the FDIC stands behind the bank.

• Accounting definition: a maturity of 90 days or less
• Money market definition: a maturity of 1 year or less
• Defining trait: principal preservation, not growth or income maximization

Exam Tip: Gotchas

The exam may offer 90 days as a distractor for a money market instrument's maturity limit. Ninety days is the narrower accounting definition of a cash equivalent; the broader money market convention used for commercial paper, T-bills, and similar instruments is one year or less.

What Does FDIC Insurance Actually Cover?

• Covers deposits at FDIC-member banks up to $250,000 per depositor, per insured bank, per ownership category
• Coverage applies to principal plus accrued interest (the combined total must stay within the limit)
• Separate coverage applies to each ownership category (individual, joint, trust, retirement, etc.)
• Any amount above the limit is uninsured: if the bank fails, the depositor is an unsecured creditor for the excess, so default risk applies to that part of the balance
• Does NOT cover: investment losses, stocks, bonds, mutual funds, annuities, life insurance policies
• Credit unions are insured by the NCUA (National Credit Union Administration) at the same $250,000 limit

What Are Demand Deposits and Savings Accounts?

Demand deposits are checking accounts: funds can be withdrawn on demand, without prior notice or penalty. Savings accounts and money market deposit accounts (MMDAs) are also accounts you can withdraw from at any time, but they are not checking accounts and are not demand deposits. Together these accounts are the most liquid form of cash equivalent.

• Checking accounts (demand deposits) typically pay the least interest, and some pay none
• Savings accounts pay a modest rate
• MMDAs may offer limited check-writing privileges and typically pay more than a basic savings account
• All three pay little interest, a trade-off for maximum liquidity and safety
• Insured by the FDIC up to $250,000 per depositor, per insured bank, per ownership category

Exam Tip: Gotchas

• Money market deposit accounts (MMDAs) at banks are FDIC-insured. Money market mutual funds are NOT FDIC-insured; they are securities regulated by the SEC (Securities and Exchange Commission).
• The exam tests this distinction directly, so tie the name to the regulator: "deposit account" means a bank and the FDIC, "mutual fund" means a security and the SEC.

How Do Certificates of Deposit (CDs) Work?

CDs are time deposits: the depositor agrees to leave funds with a bank or other depository institution for a specified period in exchange for a stated interest rate.

• FDIC-insured up to $250,000 per depositor, per bank, per ownership category
• Maturities range from 7 days to several years (most common: 3 months to 5 years)
• An early withdrawal penalty applies if redeemed before maturity (forfeiture of some or all interest)

What Are the Three Types of CDs?

What Makes a Negotiable CD Different?

• Minimum denomination typically $100,000 (often $1 million or more)
• Can be bought and sold in the secondary market before maturity
• Market price fluctuates with interest rates; selling before maturity may produce a gain or a loss
• FDIC insurance covers par value plus accrued interest up to $250,000, but does not protect against market losses from selling early

What Makes a Brokered CD Different?

• Purchased through a brokerage firm rather than directly from a bank
• Can represent CDs from multiple banks, which lets an investor stay within FDIC limits at each bank
• Tradable in the secondary market (subject to market risk if sold before maturity)
• No early withdrawal penalty, since the investor sells in the market instead, but the market price may fall below par

Exam Tip: Gotchas

• FDIC insurance on CDs protects against bank failure, NOT against market losses from selling a negotiable or brokered CD in the secondary market before maturity. If interest rates rise, the CD's market value falls below par even though the FDIC guarantee is unaffected.
• Standard bank CDs are NOT negotiable; brokered and negotiable CDs are. A standard CD can only be redeemed at the issuing bank, with an early withdrawal penalty, while negotiable and brokered CDs can be sold on a secondary market instead.

Can Insured Deposits Lose Purchasing Power?

Purchasing power risk is the risk that inflation outpaces a deposit's return. FDIC insurance protects covered deposits if the bank fails; it does not make the deposit's return keep pace with rising prices.

A fixed-rate CD held to maturity keeps its stated rate for its full term. A five-year CD therefore commits the investor to that rate longer than a three-month CD. The shorter CD allows an earlier choice of a new deposit, but the rate available at maturity is not guaranteed to be higher.

Checking accounts, savings accounts, and MMDAs can also lose purchasing power when their returns trail inflation. Immediate access to the money does not prevent that loss. A variable rate can change without keeping pace with inflation. To rank actual inflation losses across deposit types, compare their returns over the same period rather than relying on account names or maturities alone.

What Should You Check on Exam Day?

• Can you apply the $250,000 FDIC limit correctly across ownership categories at the same bank, not just recall the number?
• Do you know MMDAs (FDIC-insured, bank deposits) from money market mutual funds (SEC-regulated securities, not insured)?
• Can you explain why FDIC insurance covers bank failure but not an early-sale market loss or a loss of purchasing power?
• Do you remember that a standard bank CD has no secondary market and carries an early withdrawal penalty, while negotiable and brokered CDs trade instead?
• Can you distinguish the 90-day accounting definition of a cash equivalent from the 1-year money market convention?