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Capital Appreciation Bonds

Q

I am in a bit of a quandary. I am attempting to find specific information on CABs (Capital Appreciation Bonds), such as how they work exactly and the relation to a refinanced structured loans. If you could provide any reference material or point me in the right direction I would greatly appreciate it.

J.A., New York

A

James A. Klotz responds:

The Municipal Securities Rulemaking Board (MSRB) defines a Capital Appreciation Bond:

A municipal security on which the investment return on an initial principal amount is reinvested at a stated compounded rate until maturity, at which time the investor receives a single payment (the “maturity value”) representing both the initial principal amount and the total investment return. CABs typically are sold at a deeply discounted price with maturity values in multiples of $5,000. CABs are distinct from traditional zero coupon bonds because the investment return is considered to be in the form of compounded interest rather than accreted original issue discount. For this reason only the initial principal amount of a CAB would be counted against a municipal issuer’s statutory debt limit, rather than the total par value, as in the case of a traditional zero coupon bond.

I am not aware of any particular relationship to a “refinanced structured loan” that you refer to. CABS are frequently issued for both new capital project purposes as well as refunding issues.

For further information, you may wish to visit the MSRB’s Web site (www.msrb.org) or contact the Public Finance Department of either a regional or national investment banking firm. Such firms have great experience in structuring bond issues and are well versed in the benefits of different bond maturity schedules and related concepts.

May 17, 2005

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