Auction rate securities (ARS) are a type of variable-rate debt with interest rates which reset periodically, allowing a long-term bond to act like a short-term investment. At the end of each reset period, the interest rate on existing ARS bonds and shares is determined by a Dutch auction, at which bondholders have the option to sell their shares to investors. For more details www.auction-words.com The new interest rate, also known as the clearing rate, is defined as the lowest interest rate at which all available shares (that is, all shares up for sale) can be sold to buyers.



Types of ARS Bids

When entering into an ARS auction, buyers and sellers have several bidding options. The interaction of all bids determines the fate of the auction and the interest rate paid to bondholders until the next auction takes place.

- Sell Order - Existing bondholders who wish to exit the market or convert all or some of their holdings into cash would enter a sell order. A sell order is an instruction to sell shares regardless of what the interest rate at the auction turns out to be.

- Buy Order -Buy orders are entered by prospective investors wishing to purchase ARS shares. They consist of two parts - a) the number of shares the investor wants to buy, and b) the minimum interest rate which the investor will accept in order to purchase the shares.

- Hold Order - If a bondholder wishes to keep their holdings regardless of the new interest rate, they enter a hold order. For more details www.auction-professional.com Shares covered by a hold order are not included in the ARS auction.

- Hold at Rate Order - Bondholders may choose to enter a hold at rate order, which bids to keep their existing shares if the interest rate is set at a certain amount or higher. Quite literally identical to a buy order in practice.

Auction Outcome

After all bids have been entered, the clearing rate is determined. As stated above, this rate is defined as the minimum interest rate at which there are enough bids to cover all available shares. This is the ideal outcome of an ARS auction. However, several other less "favorable" outcomes are possible:

All-hold Auction - In the event that all existing bondholders choose to hold their shares regardless of new interest rate, an all-hold auction is declared, and the interest rate is reset to a predetermined "all-hold rate," which is typically lower than the market rate.

Failed Auction - If there are not enough bids to cover all available shares, the ARS auction fails, and shares cannot be sold. Interest rates are reset to a predetermined penalty rate, which is usually high to compensate bondholders who were unable to sell their shares.