investing bond proceeds and capital funds

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Investing Bond Proceeds and Capital Funds. Presented by Julio F. Morales April 24, 2006. The Last Step in Financing Process. Do not ignore the reinvestment of bond proceeds. Increase DSR earnings by 1.0% for 30 years: ($1 million DSR x 1.0% x 30) = $300,000. Refunding with 3% - PowerPoint PPT Presentation


  • Investing Bond Proceedsand Capital FundsPresented by Julio F. MoralesApril 24, 2006


  • The Last Step in Financing ProcessDo not ignore the reinvestment of bond proceeds Refunding with 3%savings on $10 million = $300,000

    Increase DSR earnings by 1.0% for 30 years:($1 million DSR x 1.0% x 30) = $300,000If you ignore the reinvestment of bond proceeds, you can effectively undo all your efforts

    In comparison to


  • Arbitrage Yield IRS calculation of effective interest rate paid on a tax-exempt bondIRR Calculation of Par Value vs. Adj. Debt ServicePrincipal & Interest+/- Premium / (Discount)- Bond InsuranceArbitrage Yield4.85%


  • IRS Arbitrage RegulationsArbitrage Yield the effective interest rate paid on a tax-exempt bond issue.

    Yield RestrictionIssuers are restricted from investing bond proceeds at a rate materially higher than the arbitrage yield, except in the following case:Issuer reasonably expects to spent 85% of project fund or construction fund monies) within a temporary period of 3 years.Bond proceeds held in a reasonably required reserve (i.e., DSR fund)De minimis amount = lesser of $100,000 or 5% of the bond issue.Arbitrage RebateThe IRS requires an issuer to rebate excess interest earnings above the arbitrage yield (i.e., rebate payments), generally every five (5) years. There are three primary exemptions from rebate Proceeds spent within prescribed 6-month, 18-month, or 2-year schedule. Small issuer expects to issue less than $5 million in a calendar year.Bond proceeds are invested in tax-exempt municipal securities.


  • Goals: Maximize EarningsYou must perform rebate calculationsYou get to keep all earnings up to the arbitrage yieldGoal is to invest at or above the arbitrage yieldOpportunity Cost if invested below the arbitrage yield3.00%4.00%6.00%Money Market=4.00%Investment=5.00%Opportunity CostsArbitrage Yield=4.85%Subject to rebate5.00%


  • Investment ObjectivesInvestment Principles

    Safety minimize chances of issuer defaultChance of decline in market value

    LiquidityTime constraintFunction of cash flow needs

    YieldRisk/reward ratioPortfolio Goals

    Preservation of principal Flexibility

    Investment Return

    Balance: Best return for lowest risk


  • Permitted InvestmentsMost investment policies address investment options for operating funds.Typically, investment options for bond proceeds are defined under permitted investments in the Trust Indenture / Fiscal Agent Agreement.Rating Agencies/Bond Insurers impose standard investment guidelines.


  • Investment Alternatives

    Money Market Instrument or LAIF

    Laddered Portfolio Treasury / Agency Securities, Corporate Bonds, CDs

    Investment Agreements GICs, Repos, Forward Purchase Agreements

    Combination of Above


  • The LotteryState of California offers payments of $5 million over 20 years or a single up front payment.Total over 20 years=$100 million?One-time Payoutor


  • The Lottery

    $62.3 millionTotal over 20 yearsWhich would you choose?Depends on discount rateDiscount rate = 5.0%


  • Advantages of Investment AgreementsMarket Risk Investment Agreements are par instruments that eliminate the potential market risk associated with most fixed income securities. Elimination of market risk is especially important for a long-term investment (e.g., DSR) or in a rising interest rate environment.

    Asset / Liability Management Investment Agreements can be structured to match cash flows, maturity dates, call provisions, etc. allows issuer to match assets with liabilities.

    Reinvestment Risk Issuer can lock-in the reinvestment rate (on DSR) for the life of the investment.

    Construction Risk Full-flex GICs / Repos allow issuers to make withdrawals in any amount on any date. Investment Agreements providers assume construction risk cash flow variances of withdrawal from project fund accounts.

    Default Risk Investment Agreements providers assume default risk on the bonds.

    Flexibility Investment Agreements are negotiated contracts. Issuers can structure options or contour cash flows to meet their needs.


  • Limitations of Investment AgreementsLimited Market Trading Since most Investment Agreements are structured to meet the specifications of an individual issuer (bond deal), there is no secondary market for investment agreements.Contracts can be structured with a market breakage fee (fixed income pricing)Option to Terminate (at par).

    Documentation Investment Agreements require more than just a trade confirmation. Investment agreements are structured with unique provisions; and therefore require a negotiated contract (typically 7-10 days after bidding).

    Broker / Bidding Agent - Investment agreements (like most securities) are often sold via GIC brokers or bidding agents. IRS excludes bidding fees from arbitrage calculations.


  • Break-Even Analysis



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