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.
