What are Auction Rate Securities
(ARSs)?
Auction Rate Securities (“ARS”) are municipal
bonds, corporate bonds, and preferred stocks with interest
rates or dividend yields that are periodically re-set through
auctions, typically every 7, 14, 28, or 35 days. ARS
are usually issued with stated intermediate to long-term
maturities or in perpetuity; however, due to ARS interest
rate or dividend yield re-set feature, they are priced
and traded as short-term instruments.
ARS securities were typically considered high-grade
credit quality.
Generally, ARS trade and are callable at par on the auction
date and/or any interest payment date at the option of
the issuer. Interest is paid in the current period
based on the interest rate determined in the prior auction
period. From an investor’s perspective, and
subject to the conditions discussed in more detail below,
ARS were generally viewed as an alternative to money market
funds. Typically, the minimum investment in ARS is
$25,000.
ARS are auctioned at par and the return on the investment
to the investor and the cost of financing to the issuer
between auction dates is determined by the interest rate
or dividend yield set through the auctions.
The interest rate or dividend yield is set through an
auction commonly referred to as a “Dutch” auction. A “Dutch” auction
works as follows: investors bid for a number of shares
at a desired dividend rate. Each accepted bid is
awarded securities at the Clearing Rate set during the
auction. The Clearing Rate is the lowest rate at
which there are purchasers willing to buy all auction rate
securities offered for sale in the auction. Although
bids with the lowest desired rates are filled first, the
highest rate at which the last share is filled sets the
clearing rate for all share of that particular security. If
the investor’s desired divided rate is higher than
the rate determined by the auction process, the order will
not be filled.
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