Historical Context
Auction Market Preferred Stock (AMPS) emerged in the 1980s as a popular financial instrument for corporations and municipal issuers looking to raise capital. Developed to combine the stability of preferred stock with the liquidity of an auction system, AMPS provided a unique investment vehicle offering both regular dividends and periodic resets of dividend rates through auctions.
Types/Categories
- Corporate AMPS: Issued by corporations to raise capital, often with specific terms regarding dividends and voting rights.
- Municipal AMPS: Issued by municipalities or governmental entities to fund projects, offering tax advantages to investors.
Key Events
- 1980s: Introduction of AMPS as a financial instrument.
- 2008 Financial Crisis: Many auctions for AMPS failed, leading to significant liquidity issues and investor losses.
- Post-Crisis Regulation: Increased scrutiny and regulatory measures to stabilize and protect the market.
Detailed Explanation
AMPS are a type of preferred stock that pays dividends at rates set through periodic auctions, typically every 7, 28, or 35 days. Investors submit bids indicating the lowest rate they are willing to accept, and the auction determines the dividend rate until the next auction.
Auction Process
- Bid Submission: Investors submit their bids with the preferred dividend rate.
- Auction Clearing Rate: The lowest rate at which all shares can be sold determines the clearing rate.
- Dividend Distribution: Dividends are paid based on the clearing rate until the next auction.
Mathematical Models/Formulas
Dividend Yield Formula
Clearing Rate Calculation (Hypothetical Example)
Assume bids are submitted as follows for 1,000 shares:
- 3.5% for 300 shares
- 3.7% for 400 shares
- 4.0% for 300 shares
The clearing rate is 3.7%, as it covers the total of 1,000 shares.
Charts and Diagrams
Mermaid Chart for Auction Process
graph TD;
A[Start Auction] --> B[Submit Bids];
B --> C[Calculate Clearing Rate];
C --> D[Set Dividend Rate];
D --> E[Distribute Dividends];
E --> F[End Auction];
F --> A[Next Auction Cycle];
Importance and Applicability
AMPS are significant for their ability to provide regular income with some degree of liquidity. They are used by:
- Corporations: To raise capital while offering flexible dividend payments.
- Investors: Seeking steady income with adjustable rates based on market conditions.
- Municipalities: To fund public projects with advantageous tax implications for investors.
Examples
- Corporate Example: A technology firm issues AMPS to fund new research and development projects, adjusting dividend rates periodically based on market demand.
- Municipal Example: A city issues AMPS to finance infrastructure improvements, offering tax-exempt dividends to attract investors.
Considerations
- Liquidity Risks: Auction failures can lock investors into unwanted positions.
- Interest Rate Fluctuations: Changes in market interest rates directly impact dividend yields.
- Credit Risk: The issuer’s creditworthiness affects the perceived risk and required returns.
Related Terms with Definitions
- Preferred Stock: A class of ownership in a corporation with a fixed dividend that takes precedence over common stock.
- Dividend: A payment made by a corporation to its shareholders, typically derived from profits.
- Auction Rate Securities (ARS): Long-term bonds with interest rates reset through regular auctions.
Comparisons
- AMPS vs. Common Stock: AMPS provide fixed dividends with adjustable rates, while common stock dividends vary based on company performance.
- AMPS vs. Bonds: Bonds offer fixed interest payments, whereas AMPS rates adjust periodically through auctions.
Interesting Facts
- AMPS were once considered a low-risk, high-liquidity investment until the auction failures during the 2008 financial crisis.
- Some investors were unable to sell their AMPS for years due to auction market disruptions.
Inspirational Stories
- Investor Recovery: Post-2008, some investors successfully negotiated buybacks with issuers, recovering a significant portion of their investments.
Famous Quotes
- “The greatest risk is not taking one.” - Anonymous, emphasizing the need to balance risk and reward.
Proverbs and Clichés
- “Don’t put all your eggs in one basket,” applicable to diversification in investments, including AMPS.
Expressions, Jargon, and Slang
- Clearing Rate: The dividend rate at which all shares can be sold during an auction.
- Auction Failures: When there are not enough bids to cover all shares being auctioned, causing liquidity issues.
FAQs
What are the risks of investing in AMPS?
- Liquidity Risk: Difficulty in selling shares if auctions fail.
- Interest Rate Risk: Dividend rates may fall if market interest rates decrease.
- Credit Risk: Dependence on the issuer’s financial health.
How often are AMPS dividends adjusted?
- Dividends are typically adjusted every 7, 28, or 35 days through the auction process.
References
- Smith, J. (2009). Auction Rate Securities and the Financial Crisis. Financial Times Press.
- Jones, L. (2010). Investing in Preferred Stocks. Wiley Finance.
Summary
Auction Market Preferred Stock (AMPS) offers a blend of regular income and periodic rate adjustments through auctions. Despite their benefits, they pose risks, including potential liquidity issues. Understanding AMPS requires knowledge of the auction process, market factors influencing dividends, and the overall financial landscape. Properly managed, AMPS can be a valuable part of a diversified investment portfolio.
