State of Connecticut Municipal SWAP Case Study An Analysis and Recommendation of Synthetic Fixed Rate Derivatives State of Connecticut Municipal Swap Case Study: An Analysis and Recommendation of Synthetic Fixed Rate Derivatives Dear Mr. Benson R. Cohn, We, the State of Connecticut, have typically financed the long-term capital needs of the State through tax-deductible General Obligation bonds. This allowed us to achieve a lower costof-debt than similar taxable bonds. In stark contrast to the fixed-rate long-term debt financing, short term municipal financing for our State was often achieved through innovative methods developed by Wall Street. These new funding options, commonly referred to as Variable-Rate Demand Obligations (“VRDO’s”), afforded us the ability to offer a shorter maturity, lower variable rate bond that is both callable and puttable. Puttable downside risk is covered by a Letter of Credit (“LOC”) typically provided by a Japanese Commercial bank. We have been approached by two Wall Street Banks to bring these innovations to the long-term debt market. It is in our best interest to explore these options as alternatives to raising the $325 million in tax-exempt, twenty-year debt for our state’s capital spending requirements. We know it is preferable for us to pay fixed payments for the foreseeable future in order to budget properly. The problem is that fixed rate loans for the long period of time we need require a higher rate to be paid to any willing investors compared to floating rates. Merrill Lynch and BT Securities believe that we can achieve a significantly lower cost of capital by combining the strengths of both fixed and floating rate debts. They are both offering another option that will contain an interest rate swap allowing us to synthetically pay a fixed rate on our debt but at a lower cost of capital than a normal fixed rate loan. We are