Recapturing Negative Arbitrage

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Recapturing Negative Arbitrage

• Construction Fund

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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

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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 100,000 per
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.
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