Auction rate securities (ARS) are investments that offer a high yield, similar to a certificate of deposit (CD) or money market fund. However, they are actually long-term variable rate debt with interest payments determined through auctions. This means that as interest rates increase, so does the risk and volatility of the investment. In 2008, the auction market for ARS collapsed, leaving investors unable to sell their securities. Currently, the ARS market is mostly inactive. It is crucial for investors to comprehend the risks associated with ARS before making any investments. For more information, please visit the websites of the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
Auction rate securities (ARS) were marketed as safe and high-yielding alternatives to CDs or money market funds. They are debt or preferred equity securities that have their interest rates reset periodically through auctions. These securities have long-term maturities or are issued in perpetuity. ARS were promoted as safe investments with easy access to funds. However, they are typically long-term variable rate debt with interest payments determined on a 7, 28, or 35-day basis. When interest rates rise, the interest expenses and volatility of ARS also rise, making them a higher-risk investment than fixed-rate debt. Unfortunately, the auction market for ARS collapsed in February 2008, leaving investors unable to liquidate their investments. As a result, the ARS market is now generally defunct. For example, an ARS investment could be a bond issued by a municipality or corporation that has its interest rate reset through an auction every 28 days. Another example would be a preferred stock that pays a dividend that is reset through an auction every 35 days. These examples demonstrate how ARS investments work. The interest rate or dividend payment is not fixed but rather determined through an auction process. This means that the return on investment can vary and may be higher or lower than expected.
Auction rate securities are long-term debt instruments with interest rates that are reset through periodic auctions. They are typically issued by municipalities, student loan agencies, and closed-end mutual funds.
Investors purchase auction rate securities at par value and receive interest payments based on the results of periodic auctions. These auctions determine the interest rate for the upcoming period.
While auction rate securities were once considered safe and liquid investments, they became highly illiquid during the 2008 financial crisis. Many investors were unable to sell their holdings, leading to significant losses.
The collapse of the auction rate securities market was primarily caused by the failure of major investment banks to support the auctions. These banks stopped participating in the auctions, leaving investors unable to sell their securities.
Investors who suffered losses due to the collapse of the auction rate securities market may be eligible for compensation. They can file claims against the banks and broker-dealers involved in the sale of these securities.
Investors can protect themselves by conducting thorough research before investing in auction rate securities. They should carefully review the offering documents, understand the risks involved, and consult with a qualified financial advisor.
Yes, there have been numerous legal actions against the banks and broker-dealers involved in the sale of auction rate securities. Many investors have filed lawsuits alleging fraud, misrepresentation, and violation of securities laws.
Following the collapse of the auction rate securities market, regulatory authorities implemented various measures to prevent a similar situation. These include increased disclosure requirements, stricter oversight of auction practices, and enhanced investor protection regulations.
While the auction rate securities market has significantly diminished, some issuers still offer these securities. However, investors should exercise caution and thoroughly evaluate the risks before investing.
Investors seeking similar investments to auction rate securities can consider other fixed-income instruments such as municipal bonds, corporate bonds, or Treasury securities. These investments offer more liquidity and are generally considered safer options.
This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.
This glossary post was last updated: 17th April 2024.
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