Question

Your customer, a small business owner likes investments that are short term, relatively safe from credit risk and liquid. He's heard that higher rates of return can be realized from auction rate securities than the rates he is currently getting on the Treasury bills in his portfolio. He asks you to explain them to him. Which of the following would you note as being reasons why they are not suitable for your customer? I. Auction rate securities are intended as long-term investments.II .Interest or dividend rates are reset at established intervals based on a Dutch auction.III. If the auction fails, holders of ARSs may not have immediate access to his funds.IV. The interest or dividend rate is set as the lowest rate to match supply and demand at the time of the auction

Answer 1

Correct Answer:

III. If the auction fails, holders of ARS's may not have immediate access to his funds.

Step-by-step explanation:

Auction rates securities are debt or preferred equity securities that have interest rates that are periodically re-set through auctions, typically every 7, 14, 28, or 35 days. Also, ARS are generally structured as bonds with long-term maturities (20 to 30 years) or preferred shares (issued by closed-end funds). Failure of auction leads to the holders of ARS holding their investments up to 20 -40 years which is a very high risk.