Municipal Bond Arbitrage

Municipal BondArbitrageMunicipal relative value bond arbitrage; is the investing tactic of buying ahigh quality municipal bond while at the same time selling a lower qualitycorporate bond with a less than comparable tax effective yield. www.arbitrageportfolio.com Page 1

How to Build a Municipal Bond Arbitrage Trade: • Step 1: Determine which municipal and corporate bond you are going to use to structure this trade by calculating their respective tax equivalent yields, pick the between the bonds that are below this mark. I would just arbitrage bonds with the same trading coupon rate, that way I now I will be profiting from the tax exemption benefit. • In my opinion the best type of municipal bonds to be long of are revenues backed bonds; especially if they are related to transportation taxes like toll roads. • On the other hand the best kind of corporate bonds to be short of, are high yield “junk” bonds, especially if they are issued by low growing businesses. • Step 2: Simultaneously place an order that buy municipal bonds and sell corporate bonds. • Do not take debt, in order to acquire the municipals bonds. The reason why is because of the pro rata interest disallowance rule of the American Recovery and Reinvestment Act of 2009. This rule tells us that interests paid on debt used to invest on tax exempt securities like municipals bonds are not tax deductible. www.arbitrageportfolio.com Page 2

Municipal Bonds Arbitrage Calculator www.arbitrageportfolio.com Page 3

Municipal Bond Arbitrage

by IRP Investment Corporation, INC.

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