Frequently asked questions related to Arbitrage.
Note: The information below is not to provide legal or tax advice; no person should act under any circumstances upon the information contained below.
What is Arbitrage?
Arbitrage is profit from buying in one market and selling in another.
What is an Arbitrage Bond?
Bonds are arbitrage bonds if the issuer expects to invest the proceeds at a yield, or technically computed interest rate, that is materially higher than the bond yield.
What are the Yield Restriction Requirements?
The yield restriction rules of Section 148(a) of the Code generally provide that the direct or indirect investment of the gross proceeds of bonds in investments earning a yield materially higher than the yield of the bond issue causes the bonds to be arbitrage bonds.
The chart below describes when the yield on particular investments will be “materially higher” (the chart shows the permitted yield spread between the yield on the bond issue and the yield on the particular investment; any spread beyond that stated is materially higher):
|Applicable "Materially Higher" Limits|
|Type of Investments||Materially Higher|
|general rule (when other rules below don’t apply)||1/8 of one percentage point|
|investments in a refunding escrow||1/1000 of one percentage point|
|investments allocable to replacement proceeds||1/1000 of one percentage point|
|program investments||1.5 percentage points|
|investments in tax-exempt bonds that are not subject to the alternative minimum income tax||no yield limitation|
This chart and information was obtained from https://www.irs.gov/pub/irs-pdf/p4079.pdf
What is the difference between Arbitrage Rebate and Yield Restriction?
Arbitrage Rebate mandats when you must remit arbitrage to the IRS. Yield Restriction governs when you may legally earn arbitrage without jeopardizing the tax-exempt status of the bonds.
What is a Commingled Fund?
A commingled fund is any fund or account containing both gross proceeds of an issue and amounts in excess of $25,000 that are not gross proceeds.