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Understanding Variable Rate Demand Notes (VRDNs)

VRDNs are floating rate instruments that benefit from a 1 or 7 day put option and are used in both taxable and tax-exempt money market funds.

VRDNs represent approximately 75% of the securities that make up the municipal money market space in the US. Typically, tax-exempt money market funds hold a substantial part of their portfolios in VRDNs, however, taxable funds may also purchase these securities. This guide offers insight into this important asset class.

What are VRDNs?


VRDNs are floating rate instruments with a long maturity, usually 20 or 30 years. As a floating rate instrument, VRDNs carry a coupon that resets every 1 to 7 days. VRDNs typically benefit from either a 1- or 7-day put option which allows investors to put the security back to a financial intermediary (otherwise known as a remarketing agent) at par with 1 or 7 days notice. It is this put feature at par that renders these securities eligible for purchase by money market mutual funds that are required to follow special maturity guidelines under Rule 2a-7 under the Investment Company Act of 1940. VRDNs typically reset/float off of the Securities Industry and Financial Markets Association (SIFMA) Index, which is the municipal equivalent of 7-day LIBOR. This index is reset every Wednesday at 4:15pm Eastern Standard Time. VRDNs typically benefit from external credit enhancement and liquidity support that can come in various forms. The external credit enhancement is primarily through a Letter of Credit (LOC) from a highly rated bank or financial institution that supports payment of principal and interest. The liquidity support is primarily provided through a Standby Purchase Agreement (SBPA), also from a highly rated bank or financial institution, which allows the investor to put the security back, therefore enhancing its liquidity.

Detailing Support Features:


}  LOC: An LOC provides unconditional credit enhancement. This is provided by a third-party bank or financial institution. By utilizing an irrevocable LOC, the primary source of credit and liquidity risk is shifted from the municipal issuer to the LOC provider. } SBPA: An SBPA is also a liquidity facility but it is conditional, unlike an LOC. Conditions exist in which an SBPA can be voided. These conditions include: Default of the issuer Bankruptcy of the issuer Underlying bonds fall below Investment Grade Underlying bonds become taxable }  Some issues will have neither an LOC nor an SBPA, leaving the municipality to guarantee principal and interest payments and provide for the par put.

For Institutional and Financial Professional use only.

How They Work:


Under the legal language of VRDNs, noteholders typically elect to put back their notes to the tender agent upon 7 days written notice. The tender agent then draws on the liquidity facility or LOC in order to pay for the notes. Typically, remarketing agents facilitate the put to the tender agent by taking back the VRDNs directly from noteholders. Rather than send the notes to the tender agent, remarketing agents generally try to sell the notes within a window period typically of 7 days. If the notes are successfully remarketed, the tender agent never has to take possession of the notes. If the notes are not remarketed, the tender agent must then take the notes into their inventory, thereby facilitating the par put to the original owner.

At BlackRock, we select VRDNs that are supported by well capitalized financial institutions that meet our credit standards.

Comparison with Auction Rate Securities:


There are significant differences between VRDNs and Auction Rate Securities: }  VRDNs typically carry a par put back to a highly rated financial institution which is supported by an SBPA that enhances liquidity for the security. }  Auction rate securities are sold through a Dutch Auction, which is a competitive bidding process used to determine rates on each auction date. }  Auction rate securities solely rely on a functioning market (and ample number of bidders) for liquidity.

VRDNs and BlackRocks Money Market Funds


At BlackRock, when we purchase VRDNs for the money market mutual fund portfolios that we manage, we select VRDNs that are supported by well capitalized financial institutions that meet our credit standards. We purchase VRDNs with hard 1 or 7 day put options, which increases the liquidity profile within the funds since they can be converted to cash within 1 or 7 days. We conduct detailed analysis of each VRDN on our approved list, including a thorough evaluation of the underlying municipalities. The depth and strength of our credit team is critical, as we conduct our own ongoing due diligence rather than rely on the opinions of rating agencies. Each VRDN on our approved list is fully vetted through our review process which includes approval from our internal municipal analyst, our internal bank analyst covering the sponsor bank as well as full support from BlackRocks Cash Credit Committee. This three tiered confirmation process helps BlackRock seek out only high quality VRDNs to purchase for our money market fund portfolios.

For Institutional and Financial Professional use only.

This material is provided as an educational tool and should not be considered investment advice. BlackRock cannot be held responsible for any direct or incidental loss resulting from applying any of the information provided in this publication or from any other source mentioned. BlackRock is not engaged in rendering any legal, tax or accounting advice. Please consult with a qualified professional for this type of advice. Although money market funds seek to preserve the value of ones investment at $1.00 per share, it is possible to lose money by investing in a fund. When you invest in a fund you are not making a bank deposit. Your investment is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any bank or governmental agency. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested. Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time. The opinions expressed are as of February 2011 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Any investments named within this material may not necessarily be held in any accounts managed by BlackRock. Reliance upon information in this material is at the sole discretion of the reader. Past performance is no guarantee of future results. FOR MORE INFORMATION: www.blackrock.com BlackRock is a registered trademark of BlackRock, Inc. All other trademarks are the property of their respective owners. Prepared by BlackRock Investments, LLC, member FINRA. 2011 BlackRock, Inc. All Rights Reserved.
Lit. No. VRDN-BR-0512 CM5273-0512