State of Connecticut Municipal Bond Study Essay

2156 Words Mar 2nd, 2015 9 Pages
State of Connecticut Municipal SWAP Case Study An Analysis and Recommendation of Synthetic Fixed Rate Derivatives State of Connecticut Municipal Swap Case Study: An Analysis and Recommendation of Synthetic Fixed Rate Derivatives Dear Mr. Benson R. Cohn, We, the State of Connecticut, have typically financed the long-term capital needs of the State through tax-deductible General Obligation bonds. This allowed us to achieve a lower costof-debt than similar taxable bonds. In stark contrast to the fixed-rate long-term debt financing, short term municipal financing for our State was often achieved through innovative methods developed by Wall Street. These new funding options, commonly referred to as Variable-Rate Demand Obligations (“VRDO’s”), …show more content…
These fixed rates are great for the state because payments on the bonds for the next 20 years are now known and can be accounted for in the budget. If interest rates were to rise, it would not affect the state as it would only drive down the price of the bonds that the investor holds. If interest rates were to lower, then the state could call the bonds and reissue debt at a lower rate. The state would bear some credit risk but not as much as the investors. The state is not likely to default on set payments, but the investor would no longer receive payments if the state entered default. A floating rate debt would require the state to pay a floating interest rate on all bonds issued. These interest rates would follow an index comprised of similar bonds, in this case municipal. The index proposed by Merrill Lynch would be the JJ Kenny index while BT Securities would use the TENR index. These floating interest payments take all interest rate risk off the investor and place it on the state. If interest rates were to rise, then the state would have to pay more interest, thus increasing the risk of default or the addition of new funds. Credit risk would still mostly fall on the investor unless believing that the federal government would make good on all debt issued by the state in the case of default. The last form of debt are the Variable Rate Debt Obligations, VRDOs, offered

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