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Investment Agreement
Investment Agreements, also referred to as Guaranteed Investment
Contracts, are ideal for the investment of proceeds
from tax-exempt and taxable bond issues including construction,
debt service reserve and revenue funds. An Investment Agreement
pays a fixed rate of interest or a floating rate based on a predetermined
index as specified in the bidding documents. The Investment Agreement
permits the issuer to withdraw any amount of money, at any time,
without any cost or penalty, for any program purpose.
Investment Agreements are contractual obligations issued by banks,
insurance companies and other entities. The Investment Agreement
Providers are generally rated "AA" and "AAA" and
for added safety, the Investment Agreement will often include a "downgrade
provision." This will provide that in the event the rating
of the Investment Agreement Provider decreases below a certain
predetermined threshold, the Investment Agreement Provider will
be required to post collateral (U.S. Treasuries and Agencies) or
allow all funds to be withdrawn without cost or penalty.
Since funds can be withdrawn without cost or penalty, on an as
needed basis, the bond issuer is not exposed to any market risk
or interest rate risk. That is, the issuer is not subject to the
risk of liquidating securities at a loss in the event that funds
are needed sooner than anticipated in a higher interest rate environment.
The issuer is also protected from the risk of having to invest
at lower interest rates in the event that investments mature before
funds are needed. This is a risk that can occur in any interest
rate environment since the term of any funds reinvested in this
scenario may be quite short.
The interest rates provided by Investment Agreements are set
through a bid process and are typically close to or above the arbitrage
yield of the bond issue from which the proceeds are being invested.
Thus the issuer, while minimizing his investment risk, earns a
yield that is close to or the entire yield that is legally permitted.
It is worth noting that under the Tax Code, any investment losses
are borne solely by the issuer, but any profit (above the arbitrage
yield) is subject to rebate to the U.S. Treasury.
The advantages of Investment Agreements may be summarized as
follows:
- The Investment Agreement guarantees a fixed yield, or spread
versus an index rate, determined in advance.
- Funds may be withdrawn
without cost or penalty for any permitted purpose.
- The bond
issuer has protection in the event that the Investment Agreement
provider is downgraded.
- The Investment Agreement eliminates market
risk and reinvestment risk.
Since withdrawals at par are permitted at any time, there is
no need to "mark
to market" the investment.
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