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Old 01-18-2011, 07:37 AM   #41
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The nice thing about the CDs I own is that it only cost 2 months interest to get out of them. So while I'm taking treasury credit risk and enjoying significantly better than treasury (and 5-yr TIPS) returns, if interest rates go up, I can reset to higher market rates at an insignificant cost.
I assume that Ally includes the weaselly words about being able to forestall/deny early withdrawals at its discretion? If so, how do you evaluate the risk of the enforcing this? I have to assume that they have a mountain of hot money that thinks as we do.
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Old 01-18-2011, 08:39 AM   #42
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I assume that Ally includes the weaselly words about being able to forestall/deny early withdrawals at its discretion? If so, how do you evaluate the risk of the enforcing this? I have to assume that they have a mountain of hot money that thinks as we do.
That is indeed a risk with CDs, that the bank will change the rules mid-game. But the downside risk is small versus having a similar amount in a bond fund. I'm stuck earning 3-4% in my CDs for a couple of years as rates go up, while the Bond Index loses 5% for every 100bp increase in rates. I can live with that trade.

I can replicate the credit and market risk of the CD by buying a 5-yr treasury and holding it to maturity. Currently treasuries pay 50bp less than an Ally CD. So I'm getting 50bp for liquidity risk, which is a big spread in today's market. I'm also getting a low cost interest rate put which, as you point out, I may or may not be able to exercise. But the value of that put isn't negative, and from today's perspective, it isn't zero either. So in exchange for illiquidity, I'm getting 50bp per year and an interest rate put option with some positive value. I suspect that put option has negative convexity, so I wouldn't plan on waiting until the Fed Funds rate hits 5% before trying to exercise it. I might pull the trigger as soon as cash gets competitive, which should put me at the front of the line, but I'll evaluate that when the time comes.

** Just looked, and when I bought my CDs the spread was more like 150bp to treasuries, so the deal has gotten worse. Still good, but not as much of a home run as it used to be.
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Old 01-18-2011, 08:40 AM   #43
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Please, start another thread for the CD discussions. I'm already at my personal limit for them, just looking at different Vanguard FI choices.

Well, I'll admit to one other possibility:
We bought a new Toyota Camry for DW this last Spring. Normally, I would pay cash; but Toyota was offering 5 yrs/1.9%financing and we took that. With just over 4 years to go, I wonder if my FI will earn much more than that, just paying off the loan might be an option. My guess is that for the next year or two, it'll be almost a wash. For the final 2-3 years of the loan, FI will probably be significantly above the 1.9%
Aren't you impressed with my ability to forecast interest rates?
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