Issuers of securities use credit enhancements to raise the credit rating of a security by backing it with the credit of a third party. Credit enhancements, which may include, bond insurance and bank letters of credit, can help lower the risk of default, improve liquidity, and reduce the interest rate that issuers must pay.

Bond insurance, for example, unconditionally guarantees the payment of principal and interest on the bond if the issuer of the bond defaults. Generally, this guarantee improves the credit rating of the bond, because insured bonds typically are rated based on the credit of the insurer rather than the underlying credit of the issuer.

Tax-exempt money market funds often hold municipal securities insured by a bond insurance company. If a bond insurer is downgraded, it does not necessarily mean that the security is ineligible to be held in the money market fund. However, if the bond insurer is downgraded to the point where neither the insurer’s rating nor the bond issuer’s rating meets the standards for money market fund holdings, a money market fund must promptly determine whether it may continue to hold these securities.

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