Learn what a variable-rate demand bond is and why its reset feature and
A variable-rate demand bond is a bond with a coupon that resets frequently and a feature that allows investors to tender the bond back at par on specified dates. That combination gives it a money-market-like profile even though it is legally a longer-term security.
Because the rate resets frequently and a liquidity or remarketing mechanism often supports the tender feature, investors usually treat the bond differently from a normal long-duration fixed-rate bond. The structure is common in certain municipal markets.
An investor in a variable-rate demand bond may be able to put the bond back at par with short notice if rates or liquidity conditions change, reducing some of the usual mark-to-market uncertainty.
A student says, “If the bond has a long legal maturity, it must behave like a long-duration bond in every respect.”
Answer: No. The reset and tender features can make its economic behavior much shorter in practice.