What Funds Hold Bond Proceeds, and How Is Each Fund Invested?

The funds that hold bond proceeds are created by the bond documents, and each fund is invested differently because its purpose fixes when cash leaves and which tax limits apply to what stays.

That map is the starting point for investing bond proceeds: before comparing structures or bids, an issuer needs to know which fund each dollar sits in and what that fund is for.

This page walks through the funds by type, from the construction fund that builds the project to the rebate fund that squares things with the U.S. Treasury, and closes with why their liquidity profiles differ.

What a bond indenture's flow of funds looks like

A bond indenture's flow of funds is the ordered map the bond documents draw: the documents name each fund that holds proceeds and set the order in which money moves through those funds.

The exact set of funds, and what each one may hold, is fixed deal by deal, and bond counsel drafts and interprets those provisions.

Funds can be subdivided into accounts when the documents call for it, a point the debt service fund below illustrates.

Two definitions of proceeds run alongside this map and should not be merged.

Under 17 CFR 240.15Ba1-1(m), the SEC's municipal advisor rules define proceeds of municipal securities to include sale proceeds, investment income, and pledged funds such as reserves and sinking funds held under the bond documents.

Under the same rule, when those monies are spent to carry out the authorized purposes of the municipal securities, they cease to be proceeds.

That is the municipal advisor definition, which stands apart from the tax definitions in Treasury Regulation §1.148-1.

The tax side starts from gross proceeds: Treasury Regulation §1.148-1(b) defines gross proceeds as all proceeds of an issue plus all its replacement proceeds, and proceeds as sale proceeds, investment proceeds and transferred proceeds.

Investment proceeds are amounts received from investing proceeds, net sale proceeds are sale proceeds less the amounts invested in a reasonably required reserve or replacement fund and as part of the minor portion, and transferred proceeds are proceeds of a refunded issue that become proceeds of the refunding issue under §1.148-9.

The guide to what a bond indenture says about investing proceeds reads those provisions clause by clause.

What is the project/construction fund?

A project or construction fund holds the proceeds dedicated to building or acquiring the financed project, and it is spent down over the construction period rather than on one date certain.

GFOA puts the typical investment horizon at 12 to 36 months, lists these as typical ranges rather than rules, and says expectations vary and issuers should consult their advisory team and investment policy.

The pattern of withdrawals is the draw schedule, and estimating one is its own exercise, covered in the guide to building a draw schedule.

Because the balance steps down in stages, the question for this fund is how the structures mGIC helps issuers evaluate and competitively bid fit a staged spend-down: guaranteed investment contracts, full-flex repurchase agreements and structured portfolios of U.S. Treasury securities, the last matched to anticipated cash needs with a money-market allocation for faster-than-expected spend-down.

The federal tax frame matters here as well: under Treasury Regulation §1.148-2(e)(2)(i), net sale proceeds and investment proceeds reasonably expected to be spent on capital projects get a three-year temporary period from the issue date only if the issuer reasonably expects to meet the expenditure test, the time test and the due diligence test, and under §1.148-2(e)(2)(ii) a five-year period replaces it for capital projects with substantial construction expenditures when both the issuer and a licensed architect or engineer certify that the longer period is necessary; the temporary periods guide sets out which periods apply to which proceeds.

The dedicated page on investing a construction fund takes the term, the withdrawal provisions and the bid process in full.

What is the debt service reserve fund?

A debt service reserve fund is the issue's backstop: the MSRB glossary describes it as a fund used to pay debt service if pledged revenues fall short.

The reserve requirement is often a fixed percentage of par or of maximum annual debt service, and the MSRB notes that the size and investment of the fund generally are subject to arbitrage regulations.

The same glossary entries describe several ways a reserve can be funded: with bond proceeds, with accumulated revenues, with a surety policy, or only on a trigger, the springing reserve.

GFOA treats this fund's horizon as long-term, unlike the short-term ranges it gives the construction and capitalized interest funds.

How large a reserve counts as reasonably required, and what that does to the yield the fund can earn, is the subject of the reasonably required reserve fund rules.

The long horizon is also why the MSRB's example of a forward fits here: a forward delivery agreement may provide for the delivery of specific types of securities on specified future dates at fixed yields for the purpose of optimizing the investment of a debt service reserve fund.

The dedicated page on debt service reserve fund investment covers how that term gets built and bid.

What is the capitalized interest fund?

A capitalized interest fund holds a portion of the proceeds set aside to pay interest on the securities for a specified period, which the MSRB glossary also calls funded interest.

The MSRB notes the device is commonly used during construction of a revenue-producing project so that debt service does not begin until the project is expected to be operating.

GFOA puts the typical horizon at 6 to 18 months, again as a typical range rather than a rule.

The spending calendar follows the debt service schedule rather than a draw schedule: because the fund exists to pay interest on the securities, its withdrawals line up with interest payment dates, in the amounts that schedule sets.

The dedicated page on the capitalized interest fund covers how that known calendar shapes term and withdrawal choices.

What is the debt service fund?

A debt service fund is the account the issuer makes periodic deposits into so that debt service is paid on time, in the MSRB glossary's description.

The same entry notes the fund may contain a separate principal account and interest account, in which funds for the respective purposes are held.

GFOA's typical horizons follow that split: the interest account is usually invested for 6 months and the principal account for 12 months.

Federal tax rules single out a subset of these funds: under Treasury Regulation §1.148-1(b), a bona fide debt service fund is one used mainly to match revenues with principal and interest within each bond year.

To qualify, the fund must be depleted at least once each bond year, except for a reasonable carryover not exceeding the greater of the prior year's earnings on the fund or one-twelfth of the prior year's principal and interest payments.

Amounts in a fund that meets that definition also get a 13-month temporary period under Treasury Regulation §1.148-2(e)(5)(i), and if only part of a fund qualifies, only that part gets the 13 months.

The page on debt service funds and the arbitrage rules works through the tax treatment in full.

What does a refunding escrow hold?

A refunding escrow holds proceeds and other municipal entity funds deposited to pay principal, premium and interest on one or more issues, which is how 17 CFR 240.15Ba1-1(h) defines municipal escrow investments.

Where a spending fund's horizon comes from a draw schedule, an escrow's horizon comes from a date the documents fix: GFOA says an escrow's investment horizon depends on the redemption date.

Part of the escrow's contents may not come from the new issue at all, because §1.148-9 treats proceeds of a refunded issue that become proceeds of the refunding issue as transferred proceeds.

Securities for these accounts often come from the Treasury's State and Local Government Series, and the MSRB glossary says SLGS are most commonly used in escrow accounts for refunding bonds.

Eligibility is bounded: 31 CFR 344.1 limits SLGS securities to purchases from an eligible source of funds, categories that start with gross proceeds of tax-advantaged bonds and include amounts held with them in a refunding escrow, defeasance escrow, parity reserve fund or commingled fund, along with other amounts subject to yield limits.

Whether a particular fund falls within those categories is a determination for bond counsel, and the same section names refunding and defeasance escrows side by side, which is where the defeasance guide picks the thread up.

The offering itself has a known interruption mode: 31 CFR 344.2(l) reserves Treasury's right to change or suspend the SLGS terms when the Secretary determines that issuing obligations sufficient for the orderly financing operations of the United States cannot be done without exceeding the statutory debt limit.

During such a contingency, 31 CFR 344.7(b) lets Treasury move unredeemed Demand Deposits into special 90-day certificates of indebtedness earning simple interest at the daily factor in effect when Demand Deposit issuance was suspended, and they roll over if the contingency continues.

How the escrow is sized and funded, and whether to buy SLGS or open-market securities, are the subjects of the refunding escrow and SLGS or open-market securities guides.

What do the cost of issuance and rebate funds do?

A cost of issuance fund pays the costs of issuing the bonds, which the MSRB glossary lists as expenses such as the underwriter's discount and financial advisory, bond counsel, other counsel and rating agency fees, and a rebate fund holds arbitrage rebate amounts until they are paid to the U.S. Treasury.

The rebate rules may require that payment even where the yield restriction rules allowed the issuer to earn the arbitrage.

The tax definition reaches into the cost of issuance fund: sale proceeds under Treasury Regulation §1.148-1(b) include amounts actually or constructively received from selling the issue, including amounts used to pay underwriters' discount or compensation and accrued interest other than pre-issuance accrued interest.

The dedicated page on the cost of issuance fund covers what the fund pays and how it is invested.

On the rebate side, Treasury Regulation §1.148-3(g) makes every rebate payment due no later than 60 days after its computation date, and §1.148-3(f)(2) requires the issuer, at the final computation date, to pay enough to bring cumulative payments to 100 percent of the rebate amount.

When rebate is owed and how it is calculated are the subjects of the arbitrage rebate and rebate fund guides.

Why each fund needs a different liquidity profile

Each fund needs its own liquidity profile because its cash leaves on a different calendar: a construction fund spends in stages, a capitalized interest fund pays out on interest dates, a bona fide debt service fund must be depleted at least once each bond year, an escrow pays out on a redemption date, and a reserve fund sits long-term.

GFOA frames these as typical ranges, not rules, and repeats that expectations vary and issuers should consult their advisory team and investment policy.

At the shortest horizons, SEC Rule 2a-7 draws the frame for money market funds: a government money market fund invests 99.5 percent or more of its total assets in cash, government securities, and/or repurchase agreements that are collateralized fully.

The same rule caps the portfolio: no instrument with a remaining maturity over 397 calendar days, weighted average maturity no greater than 60 days, and weighted average life no greater than 120 days.

It also sets the liquidity floors: a fund cannot buy a non-daily-liquid asset if that would leave less than 25 percent of total assets in daily liquid assets, or a non-weekly-liquid asset if that would leave less than 50 percent in weekly liquid assets, and the daily minimum does not apply to tax-exempt funds.

A retail money market fund is one with policies and procedures reasonably designed to limit all beneficial owners of the fund to natural persons, so a retail fund's beneficial owners are natural persons rather than entities.

The SEC's July 12, 2023 reforms then changed the operating rules: they raised minimum liquidity requirements, removed the ability to impose redemption gates, and removed the link between liquidity fees and weekly liquid asset thresholds.

Under the amendments, institutional prime and institutional tax-exempt funds must charge a liquidity fee when daily net redemptions exceed 5 percent of net assets, unless the fund's liquidity costs are de minimis, and that mandatory fee does not reach government money market funds.

One definitional trap sits nearby: Treasury Regulation §1.148-1(b) says an open-end regulated investment company, such as a mutual fund, is not a commingled fund, while a commingled fund otherwise means a fund holding gross proceeds together with more than $25,000 of other amounts invested collectively.

What that distinction does and does not change for an issue's arbitrage position is arbitrage-file work, and the money market funds page takes the fund types one by one.

Across the funds, mGIC's evaluation order is safety first, then liquidity, then yield, and its reinvestment advisory reviews cover fund objectives, permitted investments, draw schedules, credit terms, market conditions and timing before anything goes to bid.

mGIC's record spans more than $60 billion in bond proceeds invested and swap notional executed, across more than 1,000 transactions for issuers in more than 40 states.

For a live issue, mGIC can review each fund's objectives, permitted investments and draw schedule in a free, no-obligation reinvestment review, and can act as Bidding Agent when a fund's investment goes out to bid, through the contact page.

Last updated 2026-10-06.

This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.