Arbitrage Bond
Contents
Unraveling the Mystery of Arbitrage Bonds: Strategies, Benefits, and Risks
Arbitrage bonds play a vital role in municipal financing, allowing municipalities to refinance higher-interest bonds with lower-rate bonds before the call date. Explore the intricacies of arbitrage bonds, their mechanisms, and the factors influencing their effectiveness.
Understanding Arbitrage Bonds
Arbitrage bonds are a financial tool utilized by municipalities to capitalize on the spread between prevailing lower market interest rates and higher coupon rates on existing bond issues. Delve into how municipalities strategically issue lower-rate bonds to reduce borrowing costs and maximize savings, especially in declining interest rate environments.
Fact: The coupon rate on arbitrage bonds should be significantly lower than the coupon rate on the higher-interest bonds to ensure the arbitrage exercise is financially viable. (source)
How an Arbitrage Bond Works
Discover the mechanics behind arbitrage bonds, including the process of pre-refunding outstanding issues with U.S. Treasury bills. Learn about the considerations involved in determining the feasibility of arbitrage, such as issuance costs and tax implications, and how municipalities navigate the tax-exempt status of refunding bonds.
Fact: Arbitrage bonds may face tax implications if not used for community development projects, potentially subjecting bondholders to federal income tax on interest payments. (source)
Limitations and Risks
Explore the limitations and risks associated with arbitrage bonds, including the possibility of IRS scrutiny and taxation if bonds are deemed to be used for profit rather than community benefit. Understand the conditions under which arbitrage bonds may qualify for temporary tax exemptions and the consequences of project delays or cancellations.