September 28, 2020
By: Teena R. Curnow - Supervisor
When a local government receives proceeds from a bond issue, it invests those proceeds until their subsequent use. Arbitrage is the difference between the arbitrage yield – the interest rate at which bonds are issued – and the investment yield – the interest rate at which the bond proceeds are invested. If the investment yield exceeds the arbitrage yield, the dollar difference in earnings is “positive arbitrage” and must be rebated to the IRS unless certain exceptions are met.
As interest rates are beginning to rise, the local government may find itself earning a “positive arbitrage” and have to turn over those excess funds. If the local government is holding on to bond proceeds from a previous year’s bond issue, it may want to work through the calculations to determine if it is getting close to that positive arbitrage amount. Bond issues with approximately three (3) percent interest rate (arbitrage yield) could have the opportunity to earn positive arbitrage with current and expected future market conditions. Please contact us with questions.