When an individual borrows money to buy a house, that borrowing enhances—or “leverages”—the buyer’s financial capacity. In combination, the loan proceeds and the borrower’s in-hand assets may allow the borrower to purchase a bigger house than would be possible without the loan and—potentially—turn a larger profit when it’s time to sell. Similarly, many mutual funds and some individual investors use leverage as they seek to enhance the returns on their assets.

In that sense, we use the term “leverage” to refer to any type of debt that a borrower takes on with the intent of investing the proceeds to earn a greater rate of return. Most investors are already familiar with various forms of leverage—e.g., mortgages, margin accounts, lines of credit and collateralized loans—and many understand the potential advantages of using them. With leverage comes the potential for greater returns or greater losses. For example, if an investment that involves leverage becomes worthless, the principal and accrued interest on the loan still must be repaid. While the form may vary, the reason for using leverage does not: leverage is intended to generate a return greater than its cost.

Two forms of leverage are most commonly used by the Oppenheimer Rochester municipal bond funds. Each fund has access to a line of credit for borrowing, and most can invest in “municipal inverse floating rate securities,” or “inverse floaters.” By prospectus, Oppenheimer Rochester Short Term Municipal Fund and Oppenheimer Rochester Intermediate Term Municipal Fund cannot invest in inverse floaters.

A fund’s line of credit (LOC) is exactly what it sounds like: an extension of credit from a financial institution. The fund typically pays a commitment fee when the LOC is set up and then pays interest on the principal amount that it borrows from the LOC. The arrangement is similar to a home equity line of credit.

The funds use the LOC to manage routine cash flows. A fund may experience cash inflows or outflows as the result of asset purchases or sales, coupon payments received, bond call or maturity proceeds, and/or purchases or redemption of shares by fund shareholders. The LOC may also be used by fund managers to seek the best execution of the purchase or sale of securities.

Inverse floaters are derivative securities that may be created when the owner (for example, a fund) of a municipal bond sells or transfers the bond to a third-party “sponsor”—generally a broker dealer—who deposits the bond into a trust. The trust then divides the bond into two derivative securities. One of these securities is a short-term, floating-rate security (the “floater”) that may be bought by money market funds. The interest rates are set at the start so that the income generated in aggregate by the two securities equals the income that would have been generated by the original bond.