What is a Municipal arbitrage Bond
Municipal bond arbitrage involves the construction loan portfolio of tax-exempt municipal bonds and simultaneously hedging the duration risk of the portfolio. Hedging occurs through the short sale of equivalent taxable corporate bonds of the same maturity, usually through interest rate swaps.
Municipal bond arbitrage is also commonly called municipal bond relative value arbitrage, municipal arbitrage, or just Muni ARB.
Breaking down the Municipal Bond arbitrage
Municipal arbitrage bond strategy aimed at minimizing credit risk and duration of using municipal bonds and interest rate swaps of similar quality and maturity. The implicit assumption in this method is a municipal bonds, and interest rate swaps will continue to have a close relationship.
Because interest on municipal bonds is exempt from Federal income taxes, arbitrager profit after tax from the municipal portfolio of securities that exceeds interest paid on interest rate swap. This strategy may be particularly attractive to investors in high income tax brackets. Arbitrage opportunities are often considered low-risk because they usually involve very little or no negative cash flow.
For example, municipal bonds often to buy a portfolio of taxes, high-quality municipal bonds. At the same time, they will sell a collection of equivalent taxable corporate bonds to profit from the tax rate. Positive, tax-free income from municipal bond arbitrage will be able to reach double figures.
The calculation of the municipal bond arbitrage requires a lot of complex factors and calculations. Calculations include the determination of the actual yield of issue of municipal bonds, the calculation of the allowable earnings using the effective yield. Then the investor will use future value calculations to the difference between the date of receipt of investment earnings and the date of calculation.
Municipal Bond Arbitrage Compliance
Exempt from the payment of tax municipal bonds of the Issuer is subject to strict Federal regulations compliance arbitration as a condition of issuance requirements such as debt obligations. All of the calculated profit that are known as the discounts must be paid to the Federal government. Federal arbitration rules are designed to prevent issuers are exempt from payment of the tax debt on the bonds with the receipt of excessive or premature debt, and therefore profit from the investment of proceeds from the sale of bonds that generate income, and investments.
Federal laws on income tax to restrict the ability to make a difference in respect of tax bonds or other Federal tax-secured bonds. Arbitrage needs to be carefully calculated and documented in accordance with the Arbitration potential IRS exam rebate. Profit should be reported for the IRS form 8038-T must be filed at least once every five years. Failure to comply with these requirements may lead to penalties or loss of tax-exempt bond status.