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S&P - Public Finance Criteria (2007). - The Global Clearinghouse

S&P - Public Finance Criteria (2007). - The Global Clearinghouse

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Other <strong>Criteria</strong>Poor’s one-third-concentration policy is a generalguideline. Funds with greater concentrations are subjectto a WAM adjustment factor and/or higher levelsof highly liquid securities.Index and spread risk in variableand floating rate securitiesVariable-rate notes (VRNs) and Floating-rate notes(FRNs) present unique market price risks. VRNsused in money funds are typically linked to conventionalmoney market indices, providing funds withyields that track short-term interest rate movements.<strong>The</strong>se investments are designed to exhibitless interest rate risk when compared with fixedrateinvestments. However, this is not the case forall VRNs. Factors affecting the value of theseinstruments include index risk and spread risk.Index risk is the risk that the coupon of a VRN willnot adjust in tandem with money market rates.Index risk can be introduced by calculating thevariable-rate coupon based on one of the following:■ A non-money index■ A money market index in which the couponadjusts based on a multiple (or fraction) of theindex, and■ An index based on the difference (or spread)between two or more indices.When analyzing VRNs in money market funds,Standard & Poor’s compares the index used in thevariable-rate adjustment formula to a standardmoney market index (e.g., the Federal Funds Rate).Standard & Poor’s believes that for all money fundsrated ‘BBBm’ and above, the index should have acorrelation of at least 95% of the effective FedFunds Rate. Additionally by this measure, nonmoneymarket fund or NAV pool indices such asthe 11th District Cost of Funds Index (COFI) andthe 10-year Constant Maturity Treasury Index areclearly unsuitable, with historical correlations ofwell below 90%.Some VRNs may use indices that are well correlatedto traditional money market indices. Yet,because of their rate adjustment formulas, they stillintroduce significant price risk. <strong>The</strong> longer theremaining life of a variable-rate security, the more itbecomes susceptible to market price deteriorationassociated with spread risk, even when tied to ahighly correlated index. Because of the potentialimpacts of spread risk on the market prices ofVRNs, Standard & Poor’s expects that rated poolslimit the remaining maturity of U.S. governmentVRNs/Floating Rate Securities (FRNs) to two yearsfor ‘AAAm’, three years for ‘AAm’, four years for‘Am’, and five years for ‘BBBm’.Corporate and structured (e.g., asset backed securitiesor ABS) VRNs/FRNs have the added risk ofcredit deterioration and are limited to final maturitiesof 13 months or less for money market fundsregistered under Rule 2a-7. For rated pools, on acase-by-case basis, consideration will be given torequests to approve holdings of FRNs/VRNs forissuers other than ‘AAA’-rated sovereigns (i.e., corporatesand ABS) with time to final maturitygreater than 397 days but no more than two years.Before granting approval to extend the maturityrange of VRN/FRN holdings, Standard & Poor’swill seek assurance that ample liquidity can bemaintained by virtue of the fund’s size, diversifiedshareholder base and range of other assets and thatadequate resources are available to analyze andmanage credit risk.If such practice is approved, all such FRNs/VRNsmust have a Standard & Poor’s short-term rating of‘A-1+’. If the Issuer does not possess a short-termrating, a Standard & Poor’s long-term rating of‘AA’ or better is required. <strong>The</strong> total holdings of allsuch VRNs will be limited to no more than 5% perIssuer and no more than 10% of net assets of thefund. <strong>The</strong> percentage of VRNs in a fund also entersinto the rating analysis to determine a fund’s overallrisk profile and is factored in on a case-by-casebasis in conjunction with the fund’s other holdings.Investing in other money market fundsStandard & Poor’s criteria calls for rated governmentinvestment pools (GIPs) that invest in othermoney market funds (also called registered investmentcompanies or RICs) to carry an identical rating.For example, a Standard & Poor’s ‘AAAm’pool may only invest in Standard & Poor’s‘AAAm’ money market funds. Standard & Poor’smoney market fund criteria for rated pools generallycalls for a maximum 25% exposure to any onefund with no stated maximum exposure. However,while no maximum is stated, Standard & Poor’swill inquire as to the feasibility of one rated fundinvesting a majority of its assets in other ratedfunds. This includes an analysis of the rated fundsposition on fee rebates since investing in anothermoney market fund will ultimately cause the shareholderto be paying fees on two funds. In addition,there are percentage limits that the investing fundmay comprise of the fund it is investing in. This isbecause it would not be prudent for the fund toinvest in another rated fund if it were going tocomprise a significant portion of its assets.DilutionA money fund or pool’s market price exposure isalso affected by the flow of money into and out ofthe fund. Standard & Poor’s analyzesshareholder/participant characteristics and behaviorin order to assess each fund’s cash-flow volatility.Stable NAV pools issue and redeem shares at $1.00,provided that their market value is between $0.995316 Standard & Poor’s <strong>Public</strong> <strong>Finance</strong> <strong>Criteria</strong> <strong>2007</strong>

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