national association of state treasurers

1. National Association of State Treasurers

3. Arbitrage Restrictions Yield Restriction - limits the time period bond proceeds can be invested above the Yield on the Bonds. Time periods: Capital projects?3 years Working capital?13 months DSRFs � unlimited, but size limited to �lesser of 3 measure� No longer significant restriction since adoption of arbitrage rebate

4. Arbitrage Rebate � If Issuer fails to meet spending tests, earnings in excess of Yield on the Bonds are �rebated� to US Treasury. �Rebate Amount� is excess of amount earned on the investment of Gross Proceeds over the amount earned if invested at the Yield on the Bonds. Spending tests generally occur sooner than temporary periods end, so arbitrage rebate more important.

5. Arbitrage Bonds Principal payments Interest payments Guarantee/Hedge fees = Bond yield Investments Principal payments Interest payments QACs = Investment yield

6. Spending Tests Six months 18 months Two Years (for Construction Issues) Tests can be applied independently, if applicable Use of spending exception not mandatory For �multipurpose issues� (e.g., new money and refunding), tests apply to each separate portion

7. Gross Proceeds Subject to Rebate Sales proceeds Investment proceeds Transferred proceeds Replacement proceeds

8. Six Month Test Spending Requirement: 95% of Gross Proceeds in six months 100% in one year Excludes DSF, DSRF, �unexpected Gross Proceeds� Rebate applies to excluded amounts absent exception. Only test applicable to refundings

9. 18 Month Test Spending Requirement: 15% of Gross Proceeds in six months 60% in one year 100% in 18 months (95% in 18 months and 100% in 30 months if unexpended 5% represents Reasonable Retainage) Lesser of 3% or $250,000 de minimis exception Similar exclusions Applies to new money not qualifying as Construction Issue

10. Two Year Test for Construction Issue Spending Requirement: 10% of Available Construction Proceeds (�ACP�) in six months 45% in one year 75% in 18 months 100% in two years (95% in two years and 100% in three years if unexpended 5% represents Reasonable Retainage) Lesser of 3% or $250,000 de minimis exception For six month, one year and 18 month spending periods, Investment Proceeds are estimated. Applies to new money qualifying as Construction Issue

11. ACP ACP equals: Issue Price Less: (DSRF) (Costs of Issuance) Plus: Investment Proceeds Election available to exclude earnings on DSRF for construction period up to two years If excluded, rebate applies from Issue Date

12. Construction Issue 75% of ACP expended for Construction Expenditures Based on expectations on Issue Date �Construction Expenditures�: construction, reconstruction, rehabilitation of real property (buildings, structures, component of buildings and structures) not acquisition of interests in land constructed personal property specially developed computer software

13. Rebate Calculation Procedure Determine Gross Proceeds Obtain Investment Records Calculate (confirm) Yield on Bonds - fixed vs. variable - �qualified guarantees� (bond insurance, LC fees) - �qualified hedges� � interest rate swaps - yield-to-call bonds, deep-discount bonds Computation of Rebate Amount

14. Rebate Amount Excess of: Future Value of receipts from investments over Future Value of payments for investments Future Value = PV x (1+i) n Universal Cap limitation Transferred Proceeds from refunded bonds

15. Rebate Compliance Calculation dates Cumulative calculation at least every 5 years Payments 90% every five years 100% after retirement Credit $1,000 per year Filing Requirement Payment is made using Form 8038-T

16. Penalties Loss of tax-exempt status 50% penalty plus interest on that amount Waiver of penalty for �innocent failure� if corrected within 180 days of discovery

17. Filing Requirements Every fifth bond year Bond year does not always mean anniversary of issue date At final redemption, including early call or reissuance Special due dates for short-term obligations

18. Unexpected Arbitrage Debt Service Funds Escrow reinvestments Yield Restriction

19. Debt Service Funds Bona-fide debt service funds are required to deplete at least once each bond year, except for a reasonable carryover amount not to exceed the greater of: Draw down balance to 1/12th of annual principal and interest payments Or Earnings on the fund for the immediately preceding bond year

20. Escrow Reinvestment Example Bond Yield = 5.35% Escrow Yield = 5.32% Escrow = $50,000,000T-Note due 6/1/2006, 6 % coupon, purchased 6/1/2005 @ 100% +scheduled 0% reinvestment of $51,500,000 6/1/2006-7/1/2006

23. SLG Window Closure Closure of SLG window precludes investment in 0% securities Do not leave funds in cash! (results in positive arbitrage) Purchase �alternative investment� (almost anything) Pay all interest earned to IRS within 180 days of receipt using 8038-T (Rev Proc 95-47)

24. Yield Restriction Definition of Yield Restricted Investments Financial instrument required to be invested at a yield that is not materially higher than the yield on the issue. Temporary Periods Possible Yield Restriction Issues Bond Yield vs. Investment Yield Series 2000-2002 bond issues requiring IRS calculations face yield reduction payments

25. Avoid These Pitfalls Commingled Funds Including Commingled Reserve and Debt Service Funds Transfers of funds to other accounts not pledged or related to the issue Deposits other than interest income Unreasonable interest income Withdrawals that are not expenditures without proper description