The Basics of Auction Rate Securities

Auction rate securities are a type of investment in which the interest rate for investors is determined by a Dutch auction. These securities are purchased through an auction format and the variable interest rates are reset through this process as well. This type of security could come in the form of a corporate bond, municipal bond or even preferred stock. Here are the basics of auction rate securities and how they work.

Purchasing Auction Rate Securities

In order to purchase auction rate securities, you have to go through your financial broker. When auction rate securities are available, you can submit a bid with the help of your broker. You will specify how many shares you want to buy as well as the minimum amount of interest that you will accept from them. The broker will then submit a bid to the auction rate security issuer. The security issuer will then take all of the bids and set the interest rate for the securities. Any investors that bid below the clearing rate will receive some of the securities according to how many shares they requested.

Resetting the Interest Rate

On these securities, issuers will hold auctions regularly in order to reset the interest rates. In some cases, these auctions can occur as often as every seven days. However, in some cases, it may happen every month instead. When one of these auctions occur, the owners of the securities can submit several different types of bids. One type of bid that can be submitted is known as a hold order. This is an order that says the investor wishes to stay involved regardless of what the new clearing rate ends up at.

A variation of this is referred to as a deemed hold bid. This means that the owner did not do anything and they will automatically retain their shares at the new rate. Hold at rate orders are another type of order that can be placed which means that the owner of the security only wants to keep them if the rate is above a certain level. Sell orders can also be placed by owners that wish to sell their securities regardless of what the rate is. Buy orders can be placed by prospective owners or existing owners contingent to a certain interest rate being met.

Benefits

This type of security provides investors with the benefit of higher interest rates than what they could get from CDs or similar bonds. Another benefit of this type of security is that it is typically insured. This means that you will at least be able to get your initial investment back regardless of what happens.

2008 Failures

This market fell apart in 2008 thanks to the financial crisis that occurred at this time. During this time period, there was a shortage of investors that were willing to get involved in the market. This meant that individual to already owned these securities could not sell them. Because of this, the value of the auction rate securities fell significantly.

blog comments powered by Disqus
Scottrade