Auction Rate Securities

First introduced in 1984, auction rate securities (also known as ARS) are long-term bonds with interest fees bound to the short-term market. These bonds are taxable and tax-exempt and the interest fees generally reset every seven, 28 or 35 days at an auction. The purpose of these securities is to allow issuers to gain long-term financing at less expensive rates in the short term.

The type of auction where the interest rates were reset is known as a Dutch auction. The auctioneer starts out with an asking price on the highest end for that particular stock and then subsequently lowers the amount. Once the auction begins it will continue until a buyer finds a called price comparable to what they are willing to pay. Depending upon the stock and the seller, there may be a reserve price set in place that the seller finds to be acceptable.

Auction rate securities sellers were made up by miscellaneous entities. Roughly half of all auction rate bonds were sold by U.S. states, cities and public authorities. The other entities include student loan agencies, closed end funds and corporations.

In February of 2008, the ARS market was completely frozen due to crumbled backing by troubled bond insurers. Many share holders were not able to sell off their securities. Issuers were also penalized as interest fees soared higher than the long-term rates. While 60 percent of investors have seen a return of their funds from ARS securities, it is estimated that roughly 40 percent of the market still remains untouchable today.

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