How Are Term Deposit Rates Calculated?


Quick Answer

Term deposit rates are calculated through the compilation of variables including investment term, deposit amount and interest rate. Financial institutions calculate the interest rates they offer customers by examining the potential profitability of a customer's deposit. For example, if a customer plans to deposit a large sum of money with a long investment term, the bank can use that money to invest in higher-gain financial products and therefore reward the customer with a higher interest rate.

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Full Answer

The investment term of a term deposit is a measure of how long the funds are expected to remain in the bank and how long the bank expects to have access to the deposit funds. Term deposit sums and interest are designed to be paid at maturity, so banks impose strict liquidity rules and harsh penalties for early withdrawals. Banks utilize term deposits as funding for high-leverage asset class purchases, and customers utilize term deposits as a middle ground between low-yield checking accounts and high-risk stocks and bonds.

The deposit amount of a term deposit is also very important to banks because money placed in term deposit accounts does not count against a bank's reserve requirements. This fact allows the bank to lend at higher volumes and make more money off its funds.

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