It's important to note that a large portion of deposits are overnight deposits. In these cases, money is borrowed or lent from today until the next business day. This makes sense when you consider a bank that needs a certain amount of cash at the end of each day. If a large cash inflow from a client didn't go through due to a technical glitch, but it's likely to clear tomorrow, the bank only needs to borrow the shortfall for a single day.

However, sometimes the funding needs is a bit longer. For instance, let's say your cash forecast shows a liquidity shortfall for the next month. In this case, you wouldn't want to borrow overnight and keep rolling it over. You'd prefer to borrow for a full month. That's where term deposits come in. Instead of borrowing overnight, the bank borrows for a specific term such as one month.

While some investors are interested in these kind of investments, they may be concerned about losing access to liquidity. Legally, there's no early exit guarantee in a one month deposit, so the money is tied up. So if an investor realizes just one day after making the deposits that they need the funds back, they could face problems. To address this issue negotiable deposits were developed in the form of certificates of deposit or CDs. Certificates of deposit are essentially receipts that acknowledge the and specify the redemption dates, maturity and interest to be paid.

These receipts can be sold to other investors who could produce the receipt on the redemption dates and get the money. This makes these investments more liquid and easier to convert into cash before maturity.

However, when it comes time to sell a CD or a certificate of deposit, the question arises at what price should the CD be sold? Fortunately, calculating the secondary market price of a CD is technically simple. It involves determining the present value of the future payments that the CD promises. This process has two steps. First, we need to calculate the future payments, and secondly, then discount that payment back to today.

Let's do an example. $100 million were originally invested in a six month CD for 182 days at 5%. However, 34 days prior to maturity, the investor is looking to sell. So the dealer quotes the current 34 day rate. For the issuer, it's 5.1%. Step one, the numerator represents the future payment of the CD at maturity. That's $100 million with 5% interest over 182 days. Using the 360 basis for US dollars, this gives us slightly more than $102.5 million, but that's the amount that's going to be promised at the maturity of the CD.

Since we're calculating the price 34 days before maturity, we need to discount this future payment back to the present, which is step two.

This is where the denominator comes in. Some of you might expect a different discounting method, such as dividing by one plus the interest rate raised to the power of time. However, simple interest is used in money markets, not compounded interest, so we discount by dividing by 1 plus the interest rate times the days over basis.

In the end, the investors selling the CD should receive $102,036,302.92.

So the calculation, while looking long and complex, is just formulaic and it can be learned relatively easily. The challenge often lies in finding a buyer and agreeing on the applicable interest rate.