Commentary

The entire closed-end fund market hit an unexpected bump recently as numerous weekly auctions failed. In this commentary, we will describe a "failed auction" and how it impacts the common shareholder and a closed-end fund overall.

How Auctions Work and How an Auction Fails

Example 1 illustrates an auction scenario in a previous piece titled "The Use of Leverage in Closed-End Funds." In this example of a "successful" auction, the number of potential buyers exceeded the number of potential sellers.

To help you understand a "failed auction," let's take this example a step further. In the new example 2, neither Potential Holder E nor Potential Holder F submitted a bid to buy shares. We have a seller of 250 shares (existing Holder A needs to liquidate) and only one new potential buyer (Holder D). Holder A wants to sell 250 shares but Holder D only needs to buy 100 shares. So what happens? In the past, the lead broker in the auction (typically, the lead underwriter in the offering of the auction rate securities) would step in and "back stop" the auction. In other words, the lead broker would buy the excess supply in order to clear the auction and thus prevent a "fail."

There was a new wrinkle this past week, however, as the lead brokers of many auctions failed to step in and "back stop" the auctions, which consequently led to "failed" auctions.

In the event of a failed auction, most—if not all—closed-end funds have put in place a maximum rate. This rate is typically based off a "reference rate," a rate that the auction rate may track multiplied by a factor of the rate.

Impact of a Failed Calamos Closed-End Fund Auction

Like all other closed-end funds, the Calamos funds have built in safeguards in the event of a failed auction. The table below outlines the maximum rate the funds will pay in the event of failed auctions.

In order to put this in perspective, let's look at the potential maximum rates for Tuesday of this past week¹:

Comparing this rate to the average 90-day rolling rate, you'll find that these rates while slightly higher (on average 20 to 50 bps in recent auctions) are actually lower by some 30 to 70 bps than the average of the last 90 days. Why is this? Since August of 2007 we have witnessed a dispersion in the auction rate markets that pushed the average Calamos closed-end fund rate some 50 to 100 bps points above that of LIBOR. Traditionally, the auction rate preferred rate had run very close to the 7-Day LIBOR rate, but a myriad of conditions had forced the two rates to separate. Couple that with the fact that the Fed has eased 225 basis points on the fed funds rate since August and you have an environment where overall short rates continue to move lower.

Fictions and Truths

Fiction: You can't get your money out.
Truth: Auctions will continue to be conducted weekly. The ability to sell shares will be based on the number of buyers who submit "good" bids to buy at the auction. In many instances this week we have seen shares change hands, however, on a pro-rata basis.

Fiction: The funds have inherent problems.
Truth: This is a liquidity issue brought about by the need for liquidity in the general auction rate market. This need for liquidity overwhelmed the lead brokers access to capital which forced them to step away from the auctions. It is not a credit issue.

Fiction: The maximum rates are double or triple more recent rates.
Truth: While this may be true for some of the municipalities mentioned in articles this week by the press, in the closed-end fund market most funds do not face onerous maximum rates.

Fiction: Failed auctions may result in downgrades from rating agencies.
Truth: The truth is that while rating agencies are monitoring the situation, a liquidity issue does not trigger a downgrade. Rating agency guidelines are driven by the ratings or valuations of the underlying fund portfolio. Net asset values in many funds over the past few days have moved higher as the general markets have rebounded.

To learn more about the Calamos auction rate preferred, please visit us on the web at www.calamos.com/closedendfunds/LevAndSwaps.aspx.

We continue to monitor developments and to work with our partners to ensure the best possible outcome for all Calamos investors.

A Word About Risk

Leverage creates risks which may adversely affect return, including the likelihood of greater volatility of net asset value and market price of common shares; and fluctuations in dividend rates on any preferred shares.

The Global Total Return and Global Dynamic Income Funds may invest up to 100% of their assets in foreign securities and invest in an array of security types and market-cap sizes, each of which has a unique risk profile. As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities. These include fluctuations in currency exchange rates, increased price volatility, and difficulty obtaining information.

Investments by the Funds in lower-rated securities involve substantial risk of loss and present greater risks than investments in higher-rated securities, including less liquidity and increased price sensitivity to changing interest rates and to a deteriorating economic environment.

There are certain risks associated with an investment in a convertible bond such as default risk—that the company issuing a convertible security may be unable to repay principal and interest—and interest rate risk—that the convertible may decrease in value if interest rates increase.

Fixed-income securities are subject to interest rate risk; as interest rates go up, the value of the debt securities in the Fund's portfolio generally will decline.

Global Total Return and Global Dynamic Income Funds may invest in derivative securities. The use of derivatives presents risks different from, and possibly greater than, the risks associated with investing directly in traditional securities. There is no assurance that any derivative strategy used by the Funds will succeed. One of the risks associated with purchasing an option is that the Funds pay a premium whether or not an option is exercised.

Shares of closed-end funds frequently trade at a market price that is below their net asset value.