Valuing 'Raise Your Rate' Certificates of Deposit

26 Pages Posted: 11 Nov 2012

See all articles by Peter A. Brous

Peter A. Brous

Seattle University

Bonnie Buchanan

Surrey Business School, University of Surrey

Anthony Orcutt

affiliation not provided to SSRN

Date Written: November 10, 2012

Abstract

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

Brous, Peter A. and Buchanan, Bonnie and Orcutt, Anthony, Valuing 'Raise Your Rate' Certificates of Deposit (November 10, 2012). Available at SSRN: https://ssrn.com/abstract=2173803 or http://dx.doi.org/10.2139/ssrn.2173803

Peter A. Brous

Seattle University ( email )

Broadway and Madison
Department of Economics & Finance
Seattle, WA 98121-4460
United States
206-296-6495 (Phone)
206-296-2486 (Fax)

Bonnie Buchanan (Contact Author)

Surrey Business School, University of Surrey ( email )

Guildford
Guildford, Surrey GU2 5XH
United Kingdom

Anthony Orcutt

affiliation not provided to SSRN ( email )

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