An interesting alternative to Money Market funds: "Auction Rate Securities"

[A HERETIC I AM]

I have yet to see this avenue mentioned in either this group or the Economics forum and i think they bear attention. For those of you that have pulled a large sum out of Equities and have it in Money Market accounts or Funds, Auction Rate Securities might be an interesting alternative.

When you invest in a Money Market fund or account, for the most part, the the manager takes the cash you put in and invests in very short term instruments; 30, 60 or 90 day Treasuries, Corporate paper, etc. Even though the underlying securities are Bonds and Notes, instruments that often see swings in their price but not their coupon rate, the manager of the fund does his best to keep the "Net Asset Value" or NAV of a Money Market fund at $1.00. What is allowed to fluctuate is the interest rate.

Auction Rate Securities (ARS) act in a similar fashion. They are issued by Municipalities, Companies and other large institutions but they are essentially long term obligations that have a short term "reset" that allows the interest rate to be determined at auction on a regular basis.

When a long term bond is originally issued, the interest rate or "coupon" rate is set. For instance you can purchase a 20 year General Electric Subordinated Debenture that pays - say - 5.65% interest. It is typically issued at "Par" or $1,000 per bond and thereafter the market will bid up or down the price of the bond depending on market forces, the credit rating of the issuer, etc., but the interest rate never changes for the life of the bond. It will pay the holder the 5.65% (or whatever) interest rate until maturity.

The ARS is issued at a par value also but instead of the price of the bond changing based on market forces, the interest rate changes, much like a Money Market account or fund.

Here is the Wikipedia page on these instruments:
http://en.wikipedia.org/wiki/Auction_rate_security

Here is the results page from Google on "Auction Rate Securities":
http://www.google.com/search?q=auction+rate+securities&ie=utf-8&oe=utf-8&aq=t&rls=org.mozilla:en-US:official&client=firefox-a

There are "MARS" where the "M" stands for Municipal. MARS have the advantage of providing tax free interest payments. This is of particular interest to investors who have large Money Market positions outside Tax Qualified accounts. MARS aren't really too helpful inside an IRA, for instance as there is no advantage to having a tax-free interest paying security in a tax deferred account. All ARS's have essentially weekly liquidity. The Auctions are regular so if you had a position, you would have to sell out of it in order to get your cash. This is an important difference between Money Market funds and ARS. Slightly less liquid but typically a better interest rate. I have learned that with these securities it is possible to gain up to 100 basis points in interest over Money Market merely because there is no fund manager to pay.

And now for the appropriate disclaimer;
The above is not a recommendation to buy nor a solicitation to purchase any particular investment. For informational purposes only. Investors should thoroughly research the risks involved in ANY investment before buying. Past performance is no guarantee of future results. Thank you and have a nice day!

[A HERETIC I AM]

1. In light of recent events and the failure of recent auctions with these securities...

They are obviously no longer something to consider. While the auction process for this type of security has been around for quite a while, the difficulties the bond insurance companies currently find themselves in have created a situation where even very well rated issuers are having difficulty getting a successful auction. What that means is if you have them, you are going to have a lot more difficulty getting rid of them unless they are called in by the issuer.

I did not recommend these in the OP, I only provided information about them. I reiterate that an investor should take into account the risks involved in making any investment.

[bain_sidhe]

2. Heh. When I first opened this post

I was thinking, "what is he smoking???" Then I noticed the date on the OP, and realized it was only up near the top of the forum because you'd added an "er... or maybe not..." post to it. ;-)

[A HERETIC I AM]

3. LOL..yeah, it was most definitely an "Err..maybe not" post.

Or a "On second thought, scratch that and forget I said anything" post!