Retail Cash Management Products FAQ

We will keep this thread to Retail Cash Management Products unless people want to learn about institutional ones also. Reason why I recommend sticking to retail ones for most people on this board is because they can be bought at many places with small min buy in. While institutional ones in general require either a Private Bank account or investment banking account and require much larger min buy in.

Retail Cash Management Products Defined:

An Auction Rate Security (ARS) is a debt instrument with a long-term nominal maturity for which the interest rate is reset through a dutch auction process, which resets the coupon rate (or dividend rate). Auctions are typically held every 1, 7, 28, or 35 days; interest on these securities is paid at the end of each auction period, or based on a separate schedule. In a dutch auction, a broker-dealer submits bids, on behalf of current and prospective investors, to the auction agent. Based on the submitted bids, the auction agent will set the next interest rate by determining the lowest rate to clear the total outstanding amount of ARS.
ARS holders do not have the right to put their securities back to the issuer; as a result no bank liquidity facility is required.
As bank liquidity has become more expensive, the auction market has become increasingly attractive to issuers seeking the low cost and flexibility of variable rate debt.

Pros and Cons of Auction Rate Securities

For issuers, ARS offer low financing cost, in some cases more attractive than traditional variable rate debt obligations (VDROs). No third-party bank support is required, and there are typically fewer parties to the financing process. ARS eliminates renewal risk and the risk of increased fees. There is no exposure to bank rating downgrades, and ARS offer the same flexibility found in traditional VRDOs.

For buyers, ARS provide a slightly higher after tax yield/ taxable yeild than money market instruments due to their complexity. Most securities are AAA rated as well as federal, state and local tax exempt but there are taxable version as well. They also provide an opportunity to diversify one's cash equivalent holdings. They require much lower min purchase amounts over VRDO's.

Some negative aspects of ARS include lower liquidity and potential drops in the coupon rate. Lower rate then VRDO's.

Auction Rate Securities Overview

The interest rate on ARS is determinded through a Dutch auction process. The total number of shares available to auction at any given period is determined by the number of existing bond holders who wish to sell or hold bonds only at a minimum yield. Existing holders and potential investors enter a competitive bidding process through broker/dealer(s). Buyers specify the number of shares, in denominations of $25,000, they wish to purchase with the lowest interest rate they are willing to accept.Each bid and order size is ranked from lowest to highest minimum bid rate. The lowest bid rate at which all the shares can be sold at par establishes the interest rate, otherwise known as the “clearing rate”. This rate is paid on the entire issue for the upcoming period. Investors who bid a minimum rate above the clearing rate receive no bonds, while those whose minimum bid rates were at or below the clearing rate receive the clearing rate for the next period.

Most places like Fidelity, Etrade, Scwaab, Citibank, BOA do not allow you enter a competitive bid unless your buying a large block normally over $1Million.

There are is something else called a Prefered auction rate securities theses are offered by Pimco, Nueven and Blackrock. I would stay away from these as you are buying debt from closed ended bond funds.

Just like anything else depending on where you buy your ARS from the rates will vary. I buy some from Citigroup and there rates tend to be ok. I have noticed some time Fidelity rates are better tho. And as the rate is based by demand rate leader can change from place to place. But both Citibank and Fidelity will tell you expected yeild so if you dont like what you hear you can always sell your position in 1 ARS and swap to another. I personally dont bother as I would be switching position more than likely every week.

Fidelity shows you there inventory online. You goto research then fixed income then under Muni hit resets to see current day offers. They only show you inventory tho durning market hours. Citibank requires you either call your assigned broker or an 800 number to get info on them.

Currently these instruments are yeilding taxable rates between 5.18-5.33% from Citibank. Remember bonds are quoted as a rate so you need to compound them yourself or compare them savings account APR and not APY which is compouded.

Fell free to ask any questions I will try to answer them as best I can.

BTW this are super low risk. In 20 years they have been offered there has never been 1 issue that has defaulted nor a failed auction. But I am sure either is possible.

So basically if we dont have 1mil+ to play with this isnt for us?

The OP says: "Most places like Fidelity, Etrade, Scwaab, Citibank, BOA do not allow you enter a competitive bid unless your buying a large block normally over $1 Million." So where exactly can you get say just one $25,000 share?

$1million = Submit a bid through a broker for a block of shares at an interest rate you specify.
$25,000 = Buy ARS that broker has purchased in auction

This the correct distinction?

Smith Barney Web page explaining ARS in details

Here is a better explanation of how ARS work and how Citigroup runs them. This web page is from SB web page. Only things I can see different from CPB and SB is that SB web page does not mention you are required to buy $1 Million + blocks to be allow to place "Hold order at a rate" and "Buy at Rate" orders. So it might be very possible that SB has the same rules that CPB does. I know Fidelity web page does not let you place a competitive bid at all. You have to call over the phone and they allow large block buyers to place them.

Look at the URL in ScootyPuffSr's post and click on See Current offerings. Most seem to be tax exempt and thus have the lower tax-exempt type rates.

Am I wrong to think that Fidelity will charge a minimum of $75 dollars to enter and exit one of these ARS? Their commission sheet states $1.50 per bond per transaction, which would yield $37.50 to purchase a 25K minimum block and another $37.50 to exit your position. If so, then at least through Fidelity, transaction costs can significantly cut into your earnings...

Thanks for the reply, dolmar.

CMEtrader said: So basically, these notes are bought at par (not discount like tbills)and interest (at the rate which is set via dutch auction process on the specified auction reset date) is paid on the next reset date? i.e. intrest is deposited into your trading account after the 1/7/28 day period and then the process starts over again and you can hold/buy more/or sell. Is this right?

Yes except not all issues pay interest at each reset. Some issues pay montly but thoses seem to be daily resets for the most part but not always. I have seen some weekly ones also trade with accured interest.

CMEtrader said: GE Interest Plus
Less than $15,000 - 4.80 Rate / 4.91% Yield (APY)
$15,000 to $49,999 - 5.05 Rate / 5.17% Yield (APY)
$50,000 and more - 5.30 Rate / 5.43% Yield (APY)

They are paying the same thing as ARS not better. I have seen ARS on Fidelity and Citibank going as high as a rate of 5.40% for 28 and 35 day issues. Also CMEtrader you keep forgeting one thing most MMF in general are quoted as APY thus they are compounding the rate. All bonds are quoted in terms of rate as you really cant compound the interest inside of the bond. But you can always deposit the interest into another account to compound. If you happen to get a weekly coupon payment on your interest payment and deposit it into higher yeilding MMF you should be able to out preform GE account just because you are copounding more often so even if you savings accounts pays a little less your APY between ARS and copounded interest in your savings account should end up being a little more than GE.

Also as far as Vangaurd tax-free MMF you also need to consider 1 more thing they all hold between 5-20% ATM bonds. If you buy AMT-exempt ARS they are paying between 3.4-3.5% which is same as Vangaurd MMF which is one of the highest yeilding one but if you are subject to ATM you going to pay taxes holding Vanguard fund on the % of AMT bonds that fund holds. For Example NY and CA are about 18% which will lower your return and if you are not subjext to AMT both Citibank and Fidelity and many other places also sell ARS that are subject to AMT and are currently paying closer to 3.7-4%.

wassy said: The real deal is that the rates are not set by Citi or Fidelity, or any firm for that matter they are set by the issuers.

I think you need to learn or look up what an "Dutch Auction" is as the issuers does not set the rates on ARS. It is an Auction just like with T-Bills. ALL ARS rates are set by Dutch Auction. Cash Management products who rate is not set by an Auction is VRDN but thoses are institutional cash management products.

wassy said: ALL are about the same. the reason that some issues appear higher today is because the reset dates might be different.

Again I dont know where your getting your information from either. Looking at both Fidelity and Citibank ARS from today. Fidelity range on Ca tax-free/AMT Exampt 7 day range from 3.05-3.43%. Citibank range on the same issue is from 3.08-3.31%. Interest rate is determinded 100% by auction if 1 issue has more agressive bidding than others that day the rate will be much lower on that issue. Citibank range on 7 day taxable ARS is between 5.02-5.26%.

Also you keep talking about ARPS which are debt sold on closed end mututal funds which can not be compared to Muni/GSE ARS. I would not buy an ARPS/PARS if you paid me 10% you know how many ARPS or PARS have defaulted? 1 in last 5 years. Do you know how many Muni or GSE ARS have defaulted? None in 20 years. I dont want to buy leaverage debit from a bond fund. I prefer to buy debit directly from a Muni/GSE who in general dont default because they have taxing authority even if they do default like OC, CA they end up paying everyone back at par. You only loose the interest due from time they file BK till they pay you back your capital and not your capital itself.

wassy said: Money Markets try to get their yields reflected high for print in the papers so you put money with them. Also, they re jigger their portfolios as their maturities roll over.

Again sorry to disagre with you but by law MMF are not allowed to hold PARS, ARPS, or Muni/GSE ARS because they require an auction to be held and you need to find a buyer at auction to get out of your position. While there has never been a failed auction it is possible.Tax-free MMF by law either hold Muni Short term discount notes avaible from all investments banks or VRDN which has demand insurance so you can get in or out at any time and Taxable MMF holds GSE/Corp short term discount notes or taxable VRDN. For example Citibank Private bank sells VRDN with T+1 and BOA requires T+5.

Most of these instruments are sold in either $25,000 or $100,000 increments. I have not seen $5000 on these yet, but it is possible Fidelity or others might internally break them up. THey are book entry anyway, so they never leave in physical form. They might also not transfer from one firm to another in odd lots. Worse, however, is that if the issue is transferred, the new firm probably won't be willing to redeem it at your request, since $5,000 is not a valid tradeable qty. remember, they trade in $25k and $100k denominations.

Again not sure were your getting your information would like me to post underwriting docs for 10-20 issues that allow min investments of $5K and because it allowed by the underwriting terms of the Bonds does not matter if the underwritter get bought by another bank/brokerage firm they must honor underwriting terms. Also almost most ARS have min $25K buy in. Most of the ones that require $100K min are 1 day resets and even thoses a lot of them really only require $25K but Fidelity or Citibank raises the min purchase amount on there own. BTW all of Citibank issues trade in $25K blocks. Fidelity and Etrade tho offer a couple of issues with that do trade in $5K blocks. Every underwritter is free to set the terms of ARS when they underwrite the bond.

If you look at Fidelity rates today they are much lower than they were yesterday. Biggest drops were on the 1 day paper but 7 day paper that resest on friday tends to reset lower normally too. basically it because people are moving there cash into these instruments ahead of the weekend. Thus the bidding is more agressive. If you look at some of the oder history there are people buying blocks larger than $1Million on some issues. You will see on monday rates will go up again to 5.25%+ for taxable and 3.40+ for tax-free.

On my screen the 5.40% APR resets are 50K minimum but that is still pretty hot. Rated AAA by both agencies gives me confidence, thanks OP.

2 Questions:
When I look at the Fidelity new offerings today, there are ARS with a "last auction date" that go as far back as JUL 2006 for short-term (7 and 28 day resets). Why would the last auction for these be so long ago when they are supposed to be reset? (oddly, when I look at the "recent trades" data, it seems that these same ARSs have been bought and sold repeatedly over the last few weeks).

Also, where can I find info on payment schedules for these ARS instruments? i.e. how/when interest payments are made (I assume each security has its own schedule) There doesn't seem to be any info regarding this on the Fidelity site. If I buy an ARS on the reset date and sell it on the next reset date is interest accrued, or paid when I sell? If I sell between payment dates, do I get a prorated interest payment later (and lose the opportunity to earn interest on my interest until I am paid), or do I sell the security at par plus accrued interest to the next buyer?

Everything I am looking at on Fidelity's site seems to be safe AAA rated short-term liquid instruments, but are there any differences between issues (other than rate and reset frequency) that need attention. I realize that there are differences between taxable/tax exempt, state-specific, and AMT issues we discussed before. But, if I'm considering two Illinois federal/state tax exempt ARS that are not subject to AMT, and both have the same reset frequency and both pay the same rate, should I be looking at any other factors?

Thanks dolmar, always appreciate your input/expertise

dolmar said: wassy said: Again sorry to disagre with you but by law MMF are not allowed to hold...Muni/GSE ARS because they require an auction to be held and you need to find a buyer at auction to get out of your position. While there has never been a failed auction it is possible.

Do you know what liquidity facilities are?</blockquote>

RichTJ99 said: This is great information indeed.

Here is a question though. If the ARS generates a commission for the broker, and the VRDN generates a far less commission, why doesnt everyone invest in the VRDN's (aside from the minimum)?

The rates are typically higher in the VRDN (right?).

Variable Rate Demand Notes

Yes VRDN= Variable Rate Demand Notes

First off you need an investment banking account at an investment bank like Goldman Saks, Beer Sterns etc or a Private Bank account at like Citigroup, BOA, Chase or Wachovia as no other bank underwrite these issues. If you shop ARS from a Place like Fidelity, E-trade, Scwaab or any other discount brokerage firm the rates on 28 or 35 ARS will come close to VRDN or could reset even higher at times. Problem you have is you are dealing with one of the most expensive broker in the world. And you think your going to get a deal from them. SB Brokers are on commision and they get no salary so why would they want to tell you, find or sell you VRDN as there is Near to nothing in commision for the broker. Do you think your broker works for free? Do you work for free?

2nd opening a Private bank account requires either having a large bussiness account or a very large bank account. Normally $2-5 Million cash/brokerage depending on the bank. And again they are not full service brokers like SB. Private bank is no different that E-trade or Fedility or any other discount brokerage. They wont tell you what to buy. You have to tell them what you want to buy.

Here are a couple of VRDN listed on Citigroup Webpage.

59259NML4 METROPOLITAN TRANSN AUTH N Y DEDICATED TAX FD RFDG-SER AAA no insurance tho. Today Reset 3.52%
64982PSG8 NEW YORK ST DORM AUTH LEASE REV MUN HLTH FACS IMPT-SER 2-2 AAA Insured. Today Reset 3.45%
47206NAD4 JAY STR DEV CORP N Y CTS FAC LEASE REV NYC-JAY STREET PJ-SER A- AA no Insurance Today Reset 3.55%
64986MFA8 NEW YORK ST HSG FIN AGY REV 240 EAST 39TH ST-SER A unrated no insurance Today Reset 3.66%

Dolmar, is it possible to buy VRDN (at BOA/HSBC/CITI/etc...) without a 1-2mil $ investment banking account? I would like to get a decent state/fed tax-exempt return on 250-350k that will stay parked for a long time (i.e. not in and out/chasing a couple of basis pts every month). The liquidity facility of VRDN seems more appealing to me (slightly higher rates too). Or is buying ARS through Fidelity the only option with an account of my size?

Fidelity has an 28 day issue reseting for 5.43% while I understand it is only A2/A rated I dont think it going to default or anything any time soon. This ARS has $25K min.

A rate of 5.43% = an APY of 5.61% which is well above most savings account and even VRDN too.

Feuerball you are paying a lot more than $2000 in management fees on $1 million. You need to understand MMF funds are quoted in 7 day APY. ARS/VRDN/Discount notes etc as a matter of fact all bonds are quote as rate.

So an APY of 5.30% = a rate of 5.18%. Most institional MMF today are paying an APY between 5.25-5.29% while VRDN are paying 5.32-5.64% and Fidelity has a couple of 28 day ARS with min $50K buy in amounts paying a rate as high as 5.46% today. So that is really a difference between of 20-50 basis points. If you compare them to Discount Notes which pay a higher rate than VRDN the difference is 40-70 basis points.

VRDN have little to no risk as you can put them to underwriter at any time with no risk to priciple as longer as the underwriter does not file BK. ARS tho are subject to dutch auction so they have a little more risk but are still pretty much risk free as most ARS carry insurance and letters of credit from underwriter.

I don't want to see this thread get archived. Any interesting going on in this realm?