What is an Auction Rate Security?
An auction rate security, ARS, is a type of debt instrument in which the interest rate is altered after the issuance of the instrument. Normally, this change in the interest rate is conducted with the use of a process known as a dutch auction. Municipal bonds and corporate bonds are two common examples of an auction rate security, although preferred stock issues can also be classified in this manner. Debt instruments that can be categorized as being auction rate securities share a couple of characteristics. First, the instrument carries a nominal maturity that is considered long term rather than short term. Second, the terms and conditions related to the issuance of the debt instrument allows for the interest rate to be adjusted through the mechanism of the dutch auction. It is important to note that not all bond types or preferred stock issues fit into this category. The concept of adjusting interest rates in an auction setting was first introduced in the late 1980s. In the course of
Auction rates securities are bonds whose valued are reset periodically via a Dutch auction. For the bond issuer they presented an opportunity to raise cash at lower rates, since the money was more liquid than a typical 20 or 30 year bond. For the holder, they were a way of generating a safe, liquid, and insured return that was generally higher than a CD or money market account. These securities could be issued closed-end fixed income funds that wants to leverage its portfolio, by utilities that want to borrow against future receivables, as well as collateralized debt obligations back by pools of mortgages. Since February 2008 though, the auction rate securities market has collapsed and many investors have been stuck unable to liquidate their securities and extract their money. It is important to note that while investors have been unable to liquidate their position, their principal technically remains whole. Many large bond houses are working to try and redeem their investors money, al
Auction Rate Securities (ARS) are typically long-term bonds or shares of perpetual preferred stock that pay short-term interest or preferred dividend rates that reset every 7, 28, or 35 days. The rate is typically established through a Dutch Auction or remarketing process which is conducted by the auction or remarketing agent (typically a large broker-dealer or bank). Until recently, ARS have been widely viewed as liquid instruments because holders of ARS may elect to tender (sell) their securities on any auction or remarketing date. In a Dutch Auction, prospective buyers submit bids for the tendered securities. A successful auction is one in which there are sufficient bids to cover the number of ARS tendered for auction or remarketing. ARS are issued by a wide range of entities, including municipalities, corporations, and closed-end funds like Seligman Select Municipal Fund, Inc. (the Fund ). The size of the ARS market is estimated to be $342 billion* and is comprised of taxable and t
Auction rate securities (ARS) are municipal securities with a variable interest rate that is set periodically through a “Dutch Auction” process. Auctions are typically held every 7, 28, or 35 days, and interest on these securities is paid at the end of each auction period. ARS trade at par and are callable at par on any interest payment date at the option of the issuer. Although ARS are issued and rated as long-term municipal bonds (20 to 30 years), they are priced and traded as short-term instruments because of the liquidity provided through the interest rate reset mechanism. During the auction, a broker-dealer submits bids, on behalf of current and prospective investors, to the auction agent—typically a bank. Based on the submitted bids, the auction agent will set the next interest rate by determining the “clearing rate,” the lowest rate to clear the total outstanding amount of ARS. The program documents for an ARS also define situations under which a “maximum rate” is used for the n
