Valuing 'Raise Your Rate' Certificates of Deposit
26 Pages Posted: 11 Nov 2012
Date Written: November 10, 2012
The “Raise Your Rate” certificate of deposit (CD) allows investors to raise the rate on their CD to the current market rate over the life of the CD. This paper presents a binomial option pricing model to value this option to raise your rate. The model also demonstrates the conditions under which the investor should choose to exercise their option and raise their rate prior to maturity. Knowing the value of this option is useful to both the bank in setting rates and investors when comparing alternative investment opportunities. The results of this model suggest that, for CDs with short maturities and low yields, the value of the option is relatively small, roughly one to four basis points, however, for CDs with longer maturities and high yields the value of the option can be as much as 30 to 70 basis points.
Keywords: real options, binomial option pricing, CDs
JEL Classification: E40, E44, G21
Suggested Citation: Suggested Citation