Refunding Escrow Deposits - REDs

DEFINITION of 'Refunding Escrow Deposits - REDs'

A type of forward financial contract that creates an obligation for its investors to purchase a particular bond issue at a specified yield at some date in the future. The money from investors is held in escrow and is used to purchase interest-bearing U.S. Treasuries, which are either sold or allowed to mature, providing proceeds to be invested into the new bond issue with an interest rate that is locked in with a forward contract.

Investors participate early in the new bond issue (typically municipal bond) but will temporarily receive taxable income from the Treasury held in escrow.

BREAKING DOWN 'Refunding Escrow Deposits - REDs'

The issuance of REDs allows investors and underwriters to circumvent restrictions in the tax code that don't allow for certain municipal bond issues to be pre-refunded. Pre-refunding is a common strategy for issuers of municipal debt, as minor swings in interest rates can amount to millions of dollars in saved interest.