Auction rate securities are long-term investments with variable interest rates that can be bought and sold frequently at auctions. They are issued by corporations and municipal governments and can be bonds or preferred stocks. In the 2008 financial crisis, the market for these securities became illiquid, causing economic turmoil.
Auction rate securities are long-term investments that pay short-term interest rates to investors. They are fixed income securities that provide a steady stream of income to investors at a variable interest rate that changes over the term of the agreement. These financial instruments are issued in the market or sold by corporations and municipal governments as a means of generating capital. There are different types of auction rate securities, and the underlying investment can be bonds, which are debt instruments, or preferred stocks, which are equity investments. In either case, the common feature is a variable interest rate.
Under the terms of a traditional fixed-income investment, the issuer pays investors ongoing interest payments at a set percentage over the term of the loan, followed by a payment for the face value of the contract once the agreement matures or expires. . The key difference in an auction rate guarantee is the changing interest rate at which payments are made. These fees are subject to change at each default auction, which generally occurs every seven to 35 days. Investors are free to sell their auction rate securities at these auctions.
Traditionally, auction rate securities become short-term investment vehicles because auctions are held so frequently. The benefit to investors has always been that they have a relatively liquid security that can be bought and sold without any problems. In a liquid investment, buyers and sellers of securities are not hard to find.
Another benefit to investors is that they are essentially investing in short-term securities, because they have the option to sell so often, but they generally earn interest rates that exceed other short-term investments. This is because while auction rate securities are technically issued as long-term 20- to 30-year contracts, they are liquid investments that can change hands at auctions before the contract expires. Investors in auction rate securities are primarily corporations and wealthy individuals.
In the global credit crisis that unfolded in financial markets in 2008, the nature of auction rate securities changed. Institutional sellers of these financial instruments were suddenly unable to find buyers at regularly scheduled auctions. Holders were later forced to hold these securities for long periods of time, even after some of the issuers defaulted on the agreement. Because some companies rely on auction rate values as a means of generating cash in the short term, the fact that this market suddenly became illiquid played a significant role in the economic turmoil that would ensue.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
