Auction Rate Securities
(This section discusses Auction Rate Securities (“ARS”). A similar investment, known as Auction Rate Preferred Shares (“ARPS”) is discussed below.)
Auction Rate Securities (“ARS”) are typically municipal bonds, corporate bonds (including bonds issued by student loan lenders) and preferred stocks with long-term maturities (sometimes 30 years or longer). ARS investors receive interest rates or dividend yields that are periodically reset at each successive auction. ARS auctions are held in regular intervals, usually every 7, 14, 28 or 35 days. In an ARS auction, a bidder will submit the lowest interest rate or dividend yield he or she is willing to accept for buying and holding the bond during the next auction interval. If a bidder “wins” the auction, he or she is required to purchase the bond at par value, and is entitled to receive interest (at the auction’s “clearing rate”) as long as the winning bidder holds the bonds.
Traditionally, the interest rates available to ARS investors have exceeded the rates available from money market funds. This is because the periodic auctions provide the opportunity for the bonds’ interest rates to be frequently adjusted to reflect current market conditions. ARS may provide investors with benefits that in some cases include competitive yields, frequent dividend/interest payments, tax exempt income and some degree of principal protection. ARS have been promoted by brokerage firms as low risk, highly-liquid investments because bond holders have the option to resell the bonds at the next available auction. As a result, many brokers have instructed their customers to use ARS as a cash or money market equivalent.