Tender Option Bond Programs

General Overview

A TOB program is typically initiated by an institutional investor, such as a mutual fund, and is implemented by a bank. The bank provides credit enhancement and remarketing services for the short maturity variable rate securities that represent the initiating investor’s leverage. The initiating investor uses this borrowed capital to purchase a longer maturing, fixed-rate bond, which is placed in a TOB trust. The short-term variable rate debt, also known as a floater, is sold to money market mutual funds with daily or weekly interest rate resets. The residual amount of income (interest earned on the longer bond less interest and fees due on the shorter floater) is available to the institutional investor. The longer maturity security held by the investor is known as the inverse floater.

“Inverse floaters: Attractive yield but beware of the risks,” Columbia Management Investment Advisers, LLC, May 2013, available at https://www.columbiamanagement.com/market-insights/white-papers/InverseFloaters

A TOB program is a financing mechanism that allows investors to make a leveraged carry trade, borrowing at short-term rates and investing in higher-yielding long-term bonds, and then pocketing the spread.

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