What it means
A variable rate demand note, often called a VRDN, combines two features. The interest rate floats, which means it is reset regularly to reflect current market rates, and the holder has a put option, which is the right to sell the note back at par (face value) after giving notice, commonly seven days.
The reset and the put together keep the price stable. If rates rise, the note's own rate rises with them, so it does not lose value, and if the holder needs the cash or becomes worried about the issuer, they can demand repayment.
Behind the put there is usually a liquidity backstop. A bank provides a letter of credit or a standby facility, which promises to supply the money if the holder asks to be repaid and the notes cannot be resold, so the real credit risk is partly that of the bank.
A remarketing agent, which is a dealer appointed by the issuer, resets the rate so that the notes can be resold at par. When holders tender (hand back) their notes, the agent finds new buyers, and the system works smoothly most of the time.
Issuers include municipalities, nonprofits and companies, and buyers include money market funds, which need liquid, low-risk assets. The nuance is that the safety depends on the strength of the bank behind the facility, and in a crisis, rates on the notes can jump sharply when the backstop is tested.
For a corporate treasurer buying VRDNs, the main attractions are yield close to money market rates, daily or weekly access and low price risk. The main checks are the issuer, the liquidity bank, the notice period and whether the interest is taxable.
In practice
Real-world examples.
Example
A money market fund buys $20 million of VRDNs issued by a city hospital. The notes reset weekly, and the fund can demand repayment on seven days' notice. The fund uses them to hold its liquidity while earning a market rate.
Example
A corporate treasurer holds $5 million of cash for an acquisition due in a few months. She buys VRDNs backed by a strong bank letter of credit. The cash is accessible at short notice, and she earns more than on an ordinary bank deposit.
Example
A university issues $30 million of VRDNs to fund a building. The remarketing agent resets the rate every week. The university saves on interest compared with a long-term fixed borrowing, but it must pay fees for the bank facility and take the rate risk.
Formula
Calculation
Interest for a period = Principal x Annual rate x Days in period / 365
A treasurer holds $1,000,000 of variable rate demand notes. The rate is reset weekly, and for the current week it is 3.65%. Interest for the week = 1,000,000 x 0.0365 x 7 / 365 = 36,500 x 7 / 365 = $700. That is $100 a day, so if the next week's rate rises to 3.90%, the interest for that week would be 1,000,000 x 0.039 x 7 / 365 = about $748, and the market value of the note would stay close to $1,000,000 throughout.Case study
Seen in the real world.
This illustrative story involves a fictional company, Eastgate Logistics, whose treasurer had $8 million set aside for new vehicles to be bought in four months. She considered a bank deposit but found a variable rate demand note offering a slightly higher yield.
The notes were backed by a letter of credit from a large bank, reset weekly and could be put on seven days' notice. She bought $8 million and earned about $5,600 a week at a 3.65% rate while waiting.
When the vehicle order was confirmed, she gave notice and received par plus accrued interest eight days later. The fictional treasurer noted in her report that the arrangement had delivered extra interest without taking price risk, but that she had checked the bank's rating before investing.
Watch out
Common mistakes.
- Treating the note as risk free. The safety depends on the issuer and the bank providing the backstop.
- Ignoring the notice period. The put is not instant, and the holder must give notice, which can matter if cash is needed urgently.
- Confusing it with a long-term bond. Although the legal maturity may be long, the frequent rate resets and the put make it behave like a short-term instrument.
Questions
People also ask.
What is the put option for?
It lets the holder demand repayment at face value, which keeps the price stable and the note liquid.
Who resets the rate?
A remarketing agent chosen by the issuer sets the rate at the level needed to sell the notes at par.
How does it differ from a variable rated demand bond?
The structure is similar, but a note is generally shorter in term and issued in the money market, while a bond is a longer-term municipal security.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related