December 31, 2006

Hedge Funds and Municipal Bonds

-- By Pushpa Sathish, Staff Writer

Following a miserable year that hasn’t exactly seen spectacular returns pouring in, hedge funds are looking to municipal funds to help revive their fortunes. These funds are investments in state and federal government projects, and allow investors to skip on federal, state and local income taxes on interest earned on them.

According to Bloomberg, recent interest in “munis” have pushed them to perform better than U.S. Treasuries and corporate bonds over the past three years. Hedge funds are not just profiting on the interest from these bonds.   

Rather, they are employing various arbitrage strategies to profit from the difference between the yields paid by longer-dated muni bonds and other, shorter-dated securities. One such strategy involves using the bonds as collateral in trusts that issue variable-rate notes.

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