Investigating the DARPS Market Meltdown Through an Investments Project

Dutch Auction Rate Preferred Stock (DARPS) was created in the 1980s as a way for fully taxable corporate investors and tax-exempt issuers to share the tax benefits of the dividends received deduction. DARPS dividend yields were reset every few weeks through an auction, minimizing price risk and allowing corporate treasurers to use the shares like a money market asset. However, as tax regimes changed, the appeal of DARPS to corporate investors waned, and broker/dealers began to market the assets more heavily to retail clients. When these dealers stopped supporting the DARPS auctions in early 2008, the individual investors lost all of their liquidity, learning the hard way that preferred stock is not a cash equivalent. In this paper, we explain how we incorporated this market drama into a traditional, Excel-based project for an undergraduate investments course