The Handbook of Municipal Bonds

CHAPTER 71

Understanding Variable Rate Demand Obligations

Mitchell Savader Chief Executive Officer The Savader Group LLC and Managing Director Civitas Funding Group LLC

 

 

 

This chapter focuses on variable-rate demand obligations (VRDOs) including important considerations when issuing or investing in municipal bonds that use this structure. VDROs have played an increasingly important role in the public finance market in recent years as they provide an attractive investment alternative for investors seeking highly liquid short-term, tax-exempt investments. They are typically purchased by money market funds due to the need to maintain a stable share price. As for obligors, VRDOs provide an efficient and effective tool for managing interest expenses by allowing for the issuance of long-term obligations using short-term interest rates. These instruments are popular with a wide variety of obligors, including state and local governments, regional, and municipally owned utilities and various not-for-profit entities such as hospitals and institutions of higher learning. The availability of municipal interest rate swaps has also contributed to the increased use of VRDOs in recent years by providing a mechanism to eliminate a major risk associated with VRDOs: exposure to increasing interest expenses over time.

HOW VRDOS WORK

Generally speaking, VRDOs are financial instruments whose yield is reset on a regular basis, such as daily, weekly, monthly, or even semiannually. As rates in the ...