Auction Rate Risk Disclosure

IMPORTANT INFORMATION ABOUT RISKS
RELATED TO AUCTION RATE SECURITIES

Auction Rate Securities (ARS) are bonds with long-term maturities that are structured to accommodate short-term holding periods. The holding period for each Auction Rate Security is set when the security is first issued. An auction takes place at the beginning of each holding period, at which the coupon or dividend is determined. At each auction, investors may (but are not required to) place orders to sell or buy. Typical holding periods are 7, 28 and 35 days.

There are several types of risks attendant to investments in ARS.

1. Liquidity Risk. Although they are designed to offer frequent opportunities to buy or sell ARS through the auction process, there is no guarantee that there will be sufficient buyers in any given auction to accommodate the orders of all potential sellers. There is no liquidity support for these securities. If there is insufficient demand to accommodate all of the sell orders, the auction will fail, in whole or in part. In that event, some or all of the investors may have to hold the security (at a newly established interest rate) until the next successful auction. There may be limited prospects for sale of ARS outside of the auction process, but liquidity is not guaranteed. When auctions fail, the securities reset to a yield specified in the bond documents. This new rate is typically above the current market rates, but rate increases are not necessarily guaranteed. Rates are reset according to the terms of the bond issuance or as may be provided by state statute, and are generally limited to a maximum, or cap, rate. At Ferris, Baker Watts, Inc., all requests to sell ARS are time-stamped upon receipt. At each auction, sell orders are executed in the order that they were received, until all buy orders are filled, at which point the auction is concluded. To the extent sell requests are left unfilled, the auction is deemed to have failed. Unfilled orders are deemed cancelled at that time. If the investor wishes to request a sale of the ARS at the next auction, the investor must submit a new sale request.

2. Conversion Risk. As rates on these securities have risen as a result of recent failed auctions, many issuers are exploring different alternatives to address the increased expenses they are facing. Many issuers are attempting to convert their auction rate securities to fixed rate or variable rate demand bonds. These new structures may not be as favorable to investors as the original terms of the ARS or could expose holders to risks not presented by the original ARS.

3. Credit Risk. As with all fixed income investments, ARS carry risk of default by the issuer. They typically have bond insurance that covers the underlying credit quality of the bond, which may mitigate this risk, depending on the financial capacity of the insurer. Further, the increased rates on variable-rate debt may increase financial pressure on some issuers. Ultimately, some issuers who experience failed auctions and who are unable to restructure this debt may not be able to pay the increased interest rates over a sustained period. A resulting deterioration in underlying credit quality could increase liquidity concerns or even result in defaults. This potential financial pressure has been compounded for some issuers who issued their auction-rate securities with offsetting interest rate swaps.

http://www.dacbond.com

Within the last twelve months, Ferris, Baker Watts, Inc., managed or co-managed a public offering of auction-rate securities. Ferris, Baker Watts, Inc., received compensation in the past twelve months, and expects to receive compensation in the next three months, for underwriting services from auction rate securities.

Ferris, Baker Watts, Inc., owns a position in several auction-rate securities.