Variable Rate Demand Note

Definition

A Variable Rate Demand Note (VRDN) is a debt instrument that represents borrowed funds, which can be repaid at any time and accrues interest based on current money market rates, such as a benchmark rate. The interest rate on the borrowed funds is determined at the inception of the debt and typically equals the specified money market rate plus an additional spread. VRDN is also known as Variable Rate Demand Obligation (VRDO).

Origin

VRDNs originated in the 1980s when financial markets needed a flexible short-term financing tool to cope with interest rate fluctuations and liquidity demands. As money markets evolved, VRDNs became a significant financing method in the municipal bond market.

Categories and Features

VRDNs are mainly categorized into municipal VRDNs and corporate VRDNs. Municipal VRDNs are typically issued by local governments for infrastructure project financing, while corporate VRDNs are issued by companies for short-term funding needs. Their main features include floating interest rates, high liquidity, and the ability to be redeemed at any time.

Case Studies

A typical case involves a city government issuing VRDNs to fund a large infrastructure project. Due to the floating interest rate, the city can reduce financing costs when rates are low. Another case is a corporation issuing VRDNs to meet short-term cash flow needs, allowing the company to manage funds flexibly and avoid the burden of long-term debt.

Common Issues

Common issues investors face with VRDNs include interest rate fluctuation risk and liquidity risk. As rates change with the market, investors may experience unstable interest income. Additionally, although VRDNs are highly liquid, redemption may be restricted during market turmoil.