Exemption from Bond Arbitrage Rules

Holders of state and local bonds are allowed to exclude interest from those bonds from their gross income. This lowers the interest that must be paid by these entities in order to attract capital and incentivizes states and localities to make capital investments. While this deduction is not allowed for bond arbitrage, the practice of profiting by issuing debt in order to acquire higher yield debt, the Energy Policy Act of 2005 carved out an exception, allowing bond arbitrage for investments in natural gas supply contracts.