Variable-Rate Demand Bond
What Is a Variable-Rate Demand Bond?
A variable-rate demand bond is a type of municipal bond (muni) with floating coupon payments that are adjusted at specific stretches. The bond is payable to the bondholder upon demand following an interest rate change. Generally, the current money market rate is utilized to set the interest rate, plus or minus a set percentage, which might bring about a change in coupon payments over the long haul.
Understanding Variable-Rate Demand Bonds
Despite the fact that bondholders might recover a demand bond out of the blue, they are frequently urged to keep these bonds to keep getting coupon payments. The floating rate of the coupon payment adds to greater vulnerability in coupon cash flows compared to generic municipal bonds, albeit a portion of this risk might be moderated by a redemption option.
Municipal bonds are issued by state and nearby legislatures to raise capital to finance public tasks, like building emergency clinics, thruways, and schools. In return for lending the municipalities money, investors are paid periodic interest as coupons as long as necessary. At maturity, the administrative issuer repays the face value of the bond to the bondholders.
Some muni bonds have fixed coupons, while others are variable. Muni bonds with floating coupon rates are called variable-rate demand bonds. The interest rates on these bonds generally are reset daily, week after week, or month to month. The bonds are issued for long-term financing with maturities going from 20 to 30 years.
What's more, variable-rate demand bonds require a form of liquidity in the event of a failed remarketing. The liquidity facility used to enhance the issuer's credit could be a letter of credit, standby bond purchase agreement (BPA), or self-liquidity, all of which help with making these securities eligible for money market funds.
For example, a letter of credit gives an unconditional commitment by a bank to pay investors the principal and interest on the variable-rate demand bonds in the event of default, bankruptcy, or a downgrade of the issuer. However long the financial institution giving the letter of credit is dissolvable, the investor will receive payment.
The Early Redemption Option
Variable-rate demand bonds are frequently issued with a embedded put feature that permits bondholders to tender the issues back to the responsible entity on the interest reset date. The put price is par plus accrued interest. The bondholders must give notice to the tender agent by a predefined number of days prior to the date that the debt securities will be tendered.
A variable-rate demand bond would regularly be put, or [exercised](/work out), on the off chance that the holder needs immediate access to their funds, or on the other hand on the off chance that market interest rates in the economy have increased to a level at which the current coupon rate on the bond isn't alluring.
In the event that the bond is tendered prior to maturity in light of an increase in rates, the [remarketing agent](/situation agent) will set a new, higher rate for the bond. Assuming market rates fall below the coupon rate, the agent will reset the rate at the most minimal rate that would try not to have a put practiced on the bond.
Features
- Municipal bonds are issued by state and nearby legislatures to raise capital to finance large public ventures.
- A variable-rate demand bond is a type of municipal bond with floating coupon payments adjusted at specific stretches.
- Compared to generic municipal bonds, the floating rate of demand bonds' coupon payments add to greater vulnerability, however a portion of this risk can be moderated.
