ARBITRAGE BOND

A lower-rate debt security issued by a municipality prior to the call date of the municipality's existing higher-rate security.

Proceeds from the issuance of lower-rate bonds are invested in treasuries until the call date of the higher-interest bonds. This strategy is used by municipalities when they wish to gain an interest-rate advantage. As long as the proceeds from net sales and investments are to be used in future projects, the bonds will qualify for a temporary tax exemption. If, however, the project experiences a significant delay or cancellation, the municipality may be taxed. Some conflicts in federal regulations can be avoided by using a ZEBRA agreement.