Fixed Deposit Basics by DEEPAM to know the difference between yields, compounding and interest rate
FIXED DEPOSITS AND CONCEPTS OF COMPOUNDING & YIELD
Fixed deposits are the most popular form of Term deposits offered by banks, companies or Govt. organizations. Other popular form of term Deposits is Recurring Deposits.
To compensate for the low liquidity, FDs offer higher rates of interest than saving accounts. Generally, the longer the term of deposit, higher is the rate of interest but a bank may offer lower rate of interest for a longer period if it expects interest rates will dip in the future.
Usually, the interest on Bank FDs is compounded every three months. from the date of the deposit. The customer may choose to have the interest paid into the savings account or reinvested in the FD. If the interest is re-invested in the FD, the deposit is called the Cumulative FD or compound interest FD. For such deposits, the interest is paid with the invested amount on maturity of the deposit at the end of the term.
Although banks can refuse to repay FDs before the expiry of the deposit, they generally don't. In most cases, banks, however charge a penalty for premature withdrawal.
Banks issue a separate receipt for every FD because each deposit is treated as a distinct contract. This receipt is known as the Fixed Deposit Receipt (FDR), that has generally to be surrendered to the bank at the time of renewal or encashment.
This addition of interest to the principal is called compounding. so that, from that moment on, the interest that has been added also earns interest. In order to define an interest rate fully, and enable one to compare it with other interest rates, the interest rate and the compounding frequency must be disclosed.
YIELD Vs. INTEREST RATE
It is important to keep the distinction between yields and interest rates always in your mind, and not to confuse one with the other.