Variable Rate Demand Note (VRDN)

What Is a Variable Rate Demand Note?

A variable-rate demand note (VRDN) is a debt instrument that addresses borrowed funds that are payable on demand and accrue interest in view of an overall money market rate, like the prime rate. The interest rate applicable to the borrowed funds is determined from the very beginning of the debt and is normally equivalent to the predetermined money market rate plus an extra margin.

A VRDN is likewise alluded to as a variable rate demand obligation (VRDO).

Understanding Variable Rate Demand Note (VRDN)

A variable-rate demand note (VRDN) is a long-term municipal bond which is offered to investors through money market funds. The notes allow a municipal government to borrow money for long periods of time while paying short-term interest rates to investors. As VRDNs are issued in at least $100,000 divisions, more modest investors can invest in VRDOs by implication through money market funds.

Since money market interest rates, for example, the bank prime rate, are variable over the long haul, the interest rate applicable to a variable rate demand note is variable too. Each time the overall money market rate changes, a variable rate demand note's interest rate is adjusted likewise. Normally, the interest rate on VRDN is adjusted daily, week after week, or month to month to mirror the current interest rate environment.

As the name infers, variable rate demand notes are payable on demand as they have an embedded put option. This means that the investor or lender of the funds can request a repayment of the whole debt amount at their circumspection, and the funds must be reimbursed once the demand has been made. Contingent upon the demand feature joined to these debt instruments, the investor might be required to give a one-day or seven-day notice to tender the securities to a financial intermediary, for example, a trustee or remarketing agent. Due to the demand feature, the maturity date of a VRDN is viewed as the next put date as opposed to its last maturity date.

One more feature of the VRDN that makes it an alluring investment option for money market investors is the credit enhancement that upholds the demand note. A credit enhancement is a feature added to a security to further develop its credit profile and relieve default risk of the underlying assets. VRDN issuers utilize credit enhancements through letters of credit (LOCs) from a profoundly rated financial institution, which fills in as the liquidity provider of last resort, committed to supporting the convenient payment of interest and repayment of principal on tendered securities. However long the financial institution giving the letter of credit is dissolvable, the investor will receive payment. Consequently, the interest rate on VRDNs will in general mirror the short-term credit rating of the bank giving the letter of credit as opposed to the municipality giving the VRDN. One more form of credit enhancement that might be utilized to reduce default risk is a standby bond purchase agreement which is ordinarily given by a reputable bank.

Variable-rate demand notes produce returns that have low correlations with stocks and bonds, consequently, making them wise investments for portfolio diversification. Also, VRDNs issued by municipalities are generally exempt from federal taxes. Many issues are additionally exempt from state taxes in the state of issue.