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.