DEFINITION of 'Auction Rate Security - ARS'

An auction rate security (ARS) is a debt security that is sold through a Dutch auction. The auction rate security is sold at an interest rate that will clear the market at the lowest yield possible. This ensures that all bidders on an ARS receive the same yield on the debt issue.

The interest rate on an ARS is reset periodically during each auction.

BREAKING DOWN 'Auction Rate Security - ARS'

Municipal and corporate issuers seeking to raise debt at a low cost and looking for the flexibility of variable rates can go the route of auction rate securities (ARS). Auction rate securities are medium- to long-term debt issues which have their interest rates determined through a Dutch auction process. ARS, in a way, acts as if it were a shorter-term issue since interest rates are reset approximately every month. A Dutch auction is a public offering auction structure in which the price of the offering is set after taking in all bids and determining the highest price at which the total offering can be sold.

Prior to the auction, brokers discuss the range of possible ARS rates with their clients. This discussion, referred to as "price talk", gives clients a basis for probable rates, but investors are free to submit bids outside of this range. Investors enter a competitive bidding process by submitting bids which specify the number of shares, in denominations of $25,000, that they are willing to purchase and the lowest interest rate that they would be willing to accept from the bond. Bids are accepted until the deadline after which the auction agent calculates the clearing rate based on the submitted bids. The clearing rate is the interest rate that will be paid on the securities until the next auction. If the investor’s bid rate is less than the clearing rate, the investor will receive all or a part of his or her desired bid. Bids placed above the clearing rate will not be filled.

Auctions for ARS are held every 7, 28, or 35 days, at which time the rates are reset. Coupons are paid either shortly after each auction period ends and the yield is settled or every quarter. Investors are drawn to these securities due to high investment grade rating in addition to the fact that they are exempt form federal, state, and local taxes. ARS also provides a slightly higher after-tax yield than money market instruments due to their complexity with an increase in risk.

In 2008, the ARS auction market failed when the four main investment banks in the market - Citigroup, UBS AG, Morgan Stanley, and Merrill Lynch - declined to act as bidders of last resort as they usually did due to liquidity concerns. Brokers who sold these securities on behalf of issuers led buyers to believe they were liquid. When the downside of ARS came to light, the auctions attracted too few bidders to establish a clearing rate, resulting in the inability of ARS holders to sell their long-term investments which had turned illiquid. In effect, a market for auction rate securities has ceased to exist.

RELATED TERMS
  1. Reserve Price

    A reserve price is the minimum amount that the owner of an item ...
  2. Absolute Auction

    An absolute auction is a type of auction where the sale is awarded ...
  3. Reverse Auction

    A reverse auction is a type of auction in which sellers bid for ...
  4. Auction Market

    An auction market is one where buyers and sellers enter competitive ...
  5. Competitive Tender

    Competitive tender is an auction process through which large ...
  6. All-Pay Auction

    An all-pay auction is an economic and game theory concept in ...
Related Articles
  1. Personal Finance

    Auction Rate Securities: Bidding On The Long Run

    These investments do better with a long-term horizon. Should you buy them before they're going, going, gone?
  2. Investing

    Explaining Dutch Auction

    A Dutch auction is a public offering auction.
  3. Investing

    eBay vs. DealDash: Comparing Auction Sites (EBAY, PYPL)

    Learn how the bidding process works at DealDash and eBay, and discover the potential pitfalls when making bids at these auction sites.
  4. Investing

    Google Expects Big Sales From AR Android Devices

    Following the success of Pokémon Go, Alphabet expects augmented reality to be the next big app.
  5. Managing Wealth

    Top Ways To Profit From Storage Auctions

    Here are some extremely valuable tips to help you become an expert at finding deals at storage auctions.
  6. Investing

    The History Of The T-Bill Auction

    Learn how the U.S. found the perfect solution to its debt problems and ended up creating one of the largest markets in the world.
  7. Investing

    Apple Forms Group for Augmented Reality

    Apple has assembled a team of experts and business veterans to push the envelope on new products using the technology.
  8. Insights

    President Trump’s Old Ferrari Auctioned After Speed Bump

    A Ferrari formerly owned by Donald Trump—the only president to have owned a supercar—was auctioned for $270,000.
  9. Tech

    E&Y Auctioning Last of Seized Bitcoin from Silk Road

    Auditing firm Ernst & Young will be auctioning off the last of the pirate booty seized from the black market site once known as Silk Road.
  10. Investing

    Why Apple's ARKit Could Be a Game Changer

    The augmented reality platform could transform the technology's prospects and Apple's revenue.
RELATED FAQS
  1. What does it mean when my broker says that shares are for auction?

    An auction market is one in which stock buyers enter competitive bids and stock sellers enter competitive offers at the same ... Read Answer >>
  2. Treasury Bond vs Treasury Note vs Treasury Bill

    Understand the types of securities the government issues. Learn the difference between Treasury notes (T-notes), Treasury ... Read Answer >>
  3. How are Treasury bill interest rates determined?

    Find out why interest rates for U.S. Treasury bills (T-bills) are determined at auction and how "competitive" bidders impact ... Read Answer >>
  4. What do the numbers after the bid and ask numbers in stock quotes mean?

    These numbers are called the bid and ask sizes, and they represent the aggregate number of pending trades at the given bid ... Read Answer >>
Trading Center