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Recapturing Negative Arbitrage

Recapturing Negative Arbitrage. Construction Fund. Next. Construction Fund. During the two-year construction period, earnings in this fund are exempt from rebate Fund investments are short-term, low-yielding investments to satisfy a construction draw down schedule

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Recapturing Negative Arbitrage

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  1. Recapturing Negative Arbitrage Construction Fund Next

  2. Construction Fund • During the two-year construction period, earnings in this fund are exempt from rebate • Fund investments are short-term, low-yielding investments to satisfy a construction draw down schedule • Fund is usually inefficient and generates negative arbitrage • Negative arbitrage generated in this fund can be recaptured with positive arbitrage earnings in the DSRF through the final maturity of the bond issue • The optimal investment strategy coordinates the investment of the construction fund and DSRF • The additional revenue potential of the construction fund is seldom realized, because few issuers fully understand these rules Next

  3. Recapturing Negative Arbitrage: “Construction Fund” $100,000,000 Issue 6% Rebate Yield Construction Fund $90,000,000 earning 5% DSRF $10,000,000 earning 7% Negative Arbitrage of 1% on Construction Fund = $900,000 per yr for 2 yrs $1,800,000 Positive Arbitrage of 1% on DSRF = $100,000per yr 1,800,000 Negative Arbitrage partially offset by – 100,000 Positive Arbitrage 1,700,000 Net Rebate Position $90,000,000 is placed into a construction fund to pay for the facility. The construction is expected to be completed in two years in accordance with a draw down schedule that complies with the rebate regulations. These proceeds will be temporarily invested in short term investments yielding 5%. The construction fund is not subject to rebate. In 2000 an institution borrows $100,000,000 to build a new facility. The cost of funds for the bond issue is 6%. $10,000,000 is placed into a DSRF. The DSRF is not subject to rebate during the two year construction period. After the two year construction period positive arbitrage earned in the DSRF can recapture negative arbitrage generated in the construction fund. Next

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