3.4.2.1 Index Debt
The interest rate payable on index debt is adjusted periodically in accordance with a published formula modified to reflect the tax treatment of the interest on the debt and the credit of the issuer. Longer term index debt may bear a higher interest rate than shorter term index debt because the longer the term of the transaction, the less precisely the benchmark index will “fit” relative to the intended performance, and debt holders are exposed to greater credit risk. Common indices include the following:
- U.S. Treasury obligation indices of various types
- The Secured Overnight Financing Rate (SOFR), an index based on U.S. Treasury repurchase agreement transactions.
- The London Interbank Offered Rate (LIBOR), a short-term taxable debt index74
- The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Index, a short term tax exempt debt index (formerly, the Bond Market Association/PSA Municipal Swap Index)
If the holder of index debt is a bank, either because the bank acquires debt directly in a private placement or because of a draw on a liquidity or credit facility, the index used is often the bank’s “prime” or “reference” rate. The interest rate formula may be subject to adjustment if the tax character of the debt changes (if the debt is no long “tax exempt”) or less frequently, if the issuer’s creditworthiness declines.