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Auction rate securities (ARS) are investments that promise 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 when interest rates rise, so does the risk and volatility of the investment. In 2008, the auction market for ARS collapsed, leaving investors unable to sell their securities. The ARS market is now mostly inactive. It is important for investors to understand the risks associated with ARS before investing.
For more information, visit the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) websites.
Auction rate securities (ARS) are investments that 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.
The auction market for ARS collapsed in February 2008, leaving investors unable to liquidate their investments. The ARS market is now generally defunct.
An example of an ARS investment would 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 illustrate 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.
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