Variable-Rate Demand Obligations (VRDOs)
In the 1980s Congress began imposing limits on certain types of bond issues. The Tax Reform Act of 1986, for example, placed a limit on the amount of tax-exempt commercial paper that could be issued by municipalities. Issuers that rolled over their commercial paper were deemed to have issued new debt. Once their debt limits were reached, any new issue would come without tax-exempt status. This would effectively eliminate any additional use of that source of funds. This new restriction led to the creation of variable-rate demand obligations (VRDOs).
VRDOs are floating-rate obligations that have a nominal long-term maturity, but whose interest rates are automatically reset on a daily, weekly, or monthly basis. They also contain a put option, which gives investors the right to put the security back to the issuer at any time, at a price equal to the bond’s face value plus accrued interest. Accrued interest is interest that has been earned but not yet been paid. With a bond that pays interest twice a year, accrued interest is the amount of interest that has been earned on a daily basis since the previous semiannual c