Investopedia explains 'Arbitrage Bond'
The chief attraction of municipal bonds is their tax exemption feature. Arbitrage bonds may qualify for a temporary tax exemption as long as the proceeds from net sales and investments are to be used in future projects. If, however, the project experiences a significant delay or cancellation, the municipality may be taxed.
The coupon rate on arbitrage bonds should be significantly below the coupon rate on the higher-interest bonds to make the arbitrage exercise worthwhile. The impact of issuance and marketing costs for the potential new bond issue are also factored into the arbitrage decision.
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