Economics
Municipal Bonds
Municipal bonds are debt securities issued by state or local governments to raise funds for public projects such as schools, roads, and utilities. Investors who purchase municipal bonds are essentially lending money to the issuing government in exchange for regular interest payments and the return of the bond's face value at maturity. Municipal bonds are often exempt from federal taxes and, in some cases, state and local taxes, making them attractive to investors in higher tax brackets.
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12 Key excerpts on "Municipal Bonds"
eBook - ePubInvesting in Fixed Income Securities
Understanding the Bond Market
- Gary Strumeyer(Author)
- 2012(Publication Date)
- Wiley(Publisher)
Chapter 10
Municipal Bonds
Over the past 10 years, the municipal market has become much more appealing to individual investors. The proliferation of bond insurance, the adaptation of municipal market data (MMD), the market’s main benchmark, electronic commerce network (ECN) trading, and increased price transparency have led many investors to believe that buying tax-free bonds is as simple as purchasing equities. This is not the case. Successful municipal bond investing necessitates a full understanding of relative value. Each municipal bond possesses unique characteristics that influence the price and thus the return on the securities. Not even all AAA bonds are created equal!Municipal Bonds are bonds issued by states and their political subdivisions: counties, cities, towns, school districts, and other governmental bodies.When you purchase new Municipal Bonds, you are in effect lending money to local governments in order to finance various public projects. For example, funds can be raised to build hospitals, schools or to repair the infrastructure.What distinguishes these bonds from other fixed income investments is the tax-exempt status of the interest paid by the municipality. Interest income received on municipal investments is not subject to federal taxes. Also, in most cases, states do not tax the interest income generated by bonds issued by that state or by any of its political subdivisions. For example, a New York State taxpayer who purchases any bond issued by New York State or any of its governmental bodies would not have to pay federal, state, or local taxes on the income produced by this bond. The interest is thus deemed to be triple tax-free for the New York City resident purchasing home-grown bonds.There are three general categories of Municipal Bonds: general obligation bonds, revenue bonds, and prerefunded/escrowed to maturity bonds.1. General obligation bonds (GOs)
eBook - ePubThe Capital Markets
Evolution of the Financial Ecosystem
- Gary Strumeyer(Author)
- 2017(Publication Date)
- Wiley(Publisher)
CHAPTER 24 Municipal Bonds Fred Yosca INTRODUCTION Municipal Bonds are debt instruments issued by states and their political subdivisions such as counties, cities, towns, school districts, and governmental agencies. When you purchase new‐issue Municipal Bonds, you are in effect lending money to finance various public projects such as the construction of hospitals, highways, and schools or the purchase of subway cars and garbage trucks. As the infrastructure of our country continues to age and the population increases, the amount of capital needed to rebuild, rehabilitate, and construct new roads, bridges, mass transit systems, and water and sewer systems will grow. The municipal bond market is the preferred venue in which those financings take place. What distinguishes Municipal Bonds from other fixed‐income investments is their tax treatment. The interest paid by municipalities on bonds issued to finance public‐purpose projects such as the ones cited earlier are exempt from federal income taxes. In most cases, states do not tax the interest income generated by the bonds they issue or the bonds issued by their political subdivisions. For example, a New York resident who purchases a bond issued by New York State or any of its political subdivisions would not have to pay federal or state income tax on the income produced by this bond. For a New York City resident purchasing an instate bond the interest is exempt from New York City income tax as well. Conversely, bonds that are issued for a nonmunicipal purpose, such as the funding of employee pensions, are fully taxable at the federal level. The last category of tax treatment for Municipal Bonds concerns bonds that are subject to the federal alternative minimum tax (AMT). Bonds whose proceeds are used for private‐purpose activities such as financings for corporations or other nongovernmental purposes will be subject to AMT
- Edwin J. Elton, Martin J. Gruber, Stephen J. Brown, William N. Goetzmann(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
However, the lack of an explicit guarantee from the federal government plus the fact that markets for agencies are frequently less liquid than markets for Treasury instruments has resulted in the agency instruments selling at slightly higher yields than Treasury notes and bonds. Municipal Bonds Municipal Bonds are debt instruments sold by political entities, such as states, counties, cities, airport authorities, school districts, and so forth, other than the federal government or its agencies. They differ from agency bonds in that they can (and in rare instances do) default and their interest is exempt from federal and usually (within the state that issues them) state taxes. The principal types of Municipal Bonds are general obli- gation bonds, which are backed by the full faith and credit (taxing power) of the issuer, and revenue bonds, which are backed either by the revenues of a particular project (e.g., a toll road) or the particular municipal agency operating the project. Because of the tax-exempt feature of Municipal Bonds, they sell at lower promised yields than nonMunicipal Bonds of the same risk. To find an equivalent yield, one must explicitly compare the discounted value of after-tax cash flows with before-tax cash flows. It is common practice to use the following approximation to the taxable equivalent yield: This approximation holds exactly only if Municipal Bonds sell at par, the treasuries they are being compared to sell at par, and the yield curve is flat. One must be particularly careful using this approximation for Municipal Bonds selling below par: while the interest payment on Municipal Bonds is tax exempt, capital gains are subject to taxation. Corporate Bonds Corporate bonds are generally similar to government bonds in pay- ment pattern. They promise to pay interest at periodic intervals and to return principal at a CHAPTER 2 FINANCIAL SECURITIES 15 4 Treasury bonds issued after 1985 do not contain call provisions.
eBook - ePub- (Author)
- 2011(Publication Date)
- Wiley(Publisher)
Chapter 2 The Basics of Municipal Securities DESCRIPTION OF MUNICIPAL SECURITIESThe municipal market includes different types of municipal securities. Traditional Municipal Bonds are interest-bearing securities issued by state and local governments on their own behalf or on behalf of qualified entities to finance capital projects and certain cash flow needs. Because interest on most of these securities is exempt from taxation at the federal level and sometimes at state and local levels, they are also called tax-exempt bonds . Build America Bonds, and certain other categories of bonds created by the American Recovery and Reinvestment Act of 2009, are subject to federal, state, and local taxes, however; they are taxable bonds .The par value, face value, or principal amount is what is paid to investors when the security comes due or matures, with interest having been paid throughout the life of the security. Generally, when a security matures in one year or more, it is a long-term financial instrument and is called a bond. Municipal Bonds usually have maturities ranging from 1 to 30 years, although some bonds have been issued with maturities ranging from 40 to 100 years. Generally, when a security has a term of less than 13 months, it is a short-term instrument. Municipal short-term instruments include notes and commercial paper. Variable-rate demand obligations (VRDOs) usually have short-term interest rate resets—and so are often treated by the market as short-term securities—but the final maturity of the security is usually long term. Zero coupon bonds do not pay interest periodically; instead, the interest accrues at the stated yield until maturity.Municipal Bonds are typically issued in denominations of $5,000 or integral multiples of $5,000, but some market terminology is based on a $1,000 bond. For example, a dealer who says “one bond” is typically referring to $1,000 par value. “Twenty-five bonds” are $25,000 par value, although there may be only five units in denominations of $5,000 each. Some municipalities have experimented with denominations as small as $100 to try to attract smaller investors, but the practice has not become widespread.
eBook - PDF- Scott Besley, Eugene Brigham, Scott Besley(Authors)
- 2021(Publication Date)
- Cengage Learning EMEA(Publisher)
127 CHAPTER 6: Bonds (Debt)—Characteristics and Valuation Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. The two principal types of munis are revenue bonds and general obligation bonds. Revenue bonds are used to raise funds for projects that will generate revenues that contribute to payment of interest and the repayment of the debt, such as a roadway that generates revenues through tolls. General obligation bonds are backed by the government’s ability to tax its citizens; special taxes or tax increases are used to generate the funds needed to service such bonds. Generally, the interest income an investor earns from munis is exempt from federal taxes. 2. As the name implies, corporate bonds are issued by businesses called corporations. A corporate bond issue generally is advertised, offered to the public, and sold to many different investors. The interest rate typically remains fixed, although the popularity of floating- rate bonds has grown during the past couple of decades. Several types of corpo- rate bonds exist, the more important of which are discussed in the remainder of this section. 3. With a mortgage bond, the corporation pledges certain tangible (real) assets as security, or collateral, for the bond. In addition to original, or first, mortgages, firms can issue second-mortgage bonds secured by the same assets. In the event of liquida- tion, the holders of these second mortgage bonds (called junior mortgages) would have a claim against the property, but only after the first-mortgage (called senior-mortgage) bondholders have been paid in full.
eBook - PDF- R. Stafford Johnson(Author)
- 2013(Publication Date)
- Bloomberg Press(Publisher)
Taxable Municipals The tax-exempt feature of many municipals makes them an attractive investment for many investors. However, there are a number of taxable Municipal Bonds, in which the interest is subject to federal income taxes. Like corporate credits, taxable municipals like Build America Bonds, sell at a lower price and higher yield than comparable tax-exempt municipals. The types of taxable municipals include those used to finance projects (e.g., sports facilities or private investors’ housing initiatives) in which there are federal restrictions that limit or prohibit financing with tax-exempt Municipal Bonds (many of these are specified in Tax Reform Act of 1986). Taxable municipals are attractive investments to tax-exempt investors (e.g., private trust) or foreign inves- tors who cannot benefit from the tax benefits of tax-exempt municipals. Exhibit 8.18 shows the Bloomberg description screen for Taxable Municipal Bonds issued by the state of Ohio as part of the Build America Bonds program. Special Features of Municipals Two features that are more common among Municipal Bonds than corporate debt secu- rities are serialization and default insurance. Serialization refers to the breaking up of a bond issue into different maturities. For example, to finance a $20 million convention center, a county might sell a serial issue with four types of securities, each with a face 346 Debt Markets and Securities value of $5 million, but with one maturing in year 5, one in year 10, one in year 15, and one in year 20 (see the Bloomberg SER screens in Exhibits 8.17 and 8.18). Instead of a serial issue, some municipals are sold with a serial maturity structure that requires a portion of the debt to be repaid each year. Like many corporate bonds, a number of mu- nicipals are sold with the principal paid at maturity. Many of these term bonds, though, often include sinking fund arrangements. There are also several GOs and revenue bonds sold as zero-discount bonds.
No longer available |Learn moreInvestments
An Introduction
- Herbert Mayo(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
The interest earned on the Treasury bonds is then used to pay the in -terest on the original bonds. In effect the municipality pays interest only on the new bonds. Once the municipal government (or authority) issues the new bonds, segregates the proceeds, and acquires the Treasury securities, the original issue is referred to as prerefunded . From the investor’s perspective, any uncertainty concerning default on interest payments and the repayment of principal is eliminated. Although prerefunded municipal debt continues to have interest rate and reinvestment rate risk, these tax-free bonds are as safe as Treasury securities. The existence of risk does not imply that an investor should avoid tax-exempt bonds. The return offered by these bonds is consistent with the amount of risk the inves -tor must bear. If a particular bond were to offer an exceptionally high return, it would be readily purchased and its price driven up so that the return was in line with comparably Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 C H A P T E R F I F T E E N Government Securities 565 risky securities. Tax-exempt bonds should be purchased by investors with moderate-to-high incomes who are seeking tax-free income and who do not need liquidity. Like any investment, tax-exempt bonds may fit into an individual investor’s portfolio and offer a return (after tax) commensurate with the risk the investor must endure. A U TH O R I T Y BOND S In addition to general obligation and revenue bonds, some local and state governments have created industrial authorities that issued bonds, built facilities, and leased them to firms. Local governments sold these industrial revenue bonds to stimulate economic growth or obtain a desired facility, such as a hospital. Since the local government au -thority and not the user issued the debt, the interest is tax-exempt.
eBook - PDF- John Mikesell(Author)
- 2017(Publication Date)
- Cengage Learning EMEA(Publisher)
If the infrastructure (streets, water and sewage systems, etc.) is not maintained, the economic advantage of new cities becomes overwhelming. Debt is not, however, the complete answer to public infrastructure deterioration; much work on maintenance is recurring and should be part of operating financing. 25 B. U. Ratchford, “Revenue Bonds and Tax Immunity,” National Tax Journal 7 (March 1954): 42. 26 For a fascinating view of public authority operation, see Robert Caro, The Power Broker: Robert Moses and the Fall of New York (New York: Vintage Books, 1975), chap. 28. 27 Some local governments have added statements about the prospect of using tax revenue if project rev-enues are not sufficient, in an effort to obtain a lower interest rate. The meaning of such a fuzzy pledge has recently been tested with cities that opted not to come up with the money when project revenues were inadequate and scheduled debt service was not paid (a default). As with most conflicts, the question will be settled in court. Michael Corkery, “The Next Credit Crisis? Munis,” Wall Street Journal , November 20, 2010, C1. In a Menasha, Wisconsin, case, a settlement was eventually negotiated, with the city using its municipal electric utility in a lease-purchase agreement with a private utility to come up with funds for the settlement, suggesting that the pledge does have some meaning. 28 George E. Peterson, “Capital Spending and Capital Obsolescence—The Outlook for Cities,” in The Fiscal Outlook for Cities , ed. Roy Bahl (Syracuse, N.Y.: Syracuse University Press, 1978), 49. Copyright 2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-300 686 Part Three: Administering Debt, Working Capital, and Pension Funds Municipal Bonds, Tax-Exempt Interest, and the Tax Reform Act of 1986 The federal income tax adopted in 1913 specified that interest on state and local government bonds would be exempt.
eBook - PDF- Jeff Madura(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
Electronic trading of Municipal Bonds has become very popular and is less expensive than dealing with a traditional broker. Websites such as E*Trade provide access to informa- tion on Municipal Bonds and allow online buying and selling of Municipal Bonds. Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 150 Part 3: Debt Security Markets 7-3e Yields Offered on Municipal Bonds The yield offered by a municipal bond differs from the yield on a Treasury bond with the same maturity for three reasons. First, the municipal bond must pay a risk premium to compensate for the possibility of default. Second, the municipal bond must pay a slight premium to compensate for being less liquid than Treasury bonds with the same matu- rity. Third, as mentioned previously, the income earned from a municipal bond is exempt from federal taxes. This tax advantage of Municipal Bonds more than offsets their two disadvantages and allows Municipal Bonds to offer a lower yield than Treasury bonds. The yield on municipal securities is commonly 20 to 30 percent less than the yield offered on Treasury securities with similar maturities. Movements in the yield offered on newly issued Municipal Bonds are highly correlated with movements in the yield offered on newly issued Treasury securities with similar maturities. 7-4 Corporate Bonds Corporate bonds are long-term debt securities issued by corporations that promise the owner coupon payments (interest) on a semiannual basis. The minimum denomination is $1,000, and their maturity is typically between 10 and 30 years.
eBook - ePub- Frank J. Fabozzi(Author)
- 2018(Publication Date)
- Wiley(Publisher)
Municipal securities are issued for various purposes. Short-term notes typically are sold in anticipation of the receipt of funds from taxes or receipt of proceeds from the sale of a bond issue, for example. Proceeds from the sale of short-term notes permit the issuing municipality to cover seasonal and temporary imbalances between outlays for expenditures and inflows from taxes. Municipalities issue long-term bonds as the principal means for financing both (1) long-term capital projects such as schools, bridges, roads, and airports, and (2) long-term budget deficits that arise from current operations.An official statement describing the issue and the issuer is prepared for new offerings. Municipal securities have legal opinions that are summarized in the official statement. The importance of the legal opinion is twofold. First, bond counsel determines if the issue is indeed legally able to issue the securities. Second, bond counsel verifies that the issuer has properly prepared for the bond sale by having enacted various required ordinances, resolutions, and trust indentures and without violating any other laws and regulations.There are basically two types of municipal security structures: tax-backed debt and revenue bonds. We describe each type as follows, as well as variants.Tax-Backed Debt
Tax-backed debt obligations are instruments issued by states, counties, special districts, cities, towns, and school districts that are secured by some form of tax revenue. Tax-backed debt includes general obligation debt, appropriation-backed obligations, debt obligations supported by public credit enhancement programs, and short-term debt instruments. We discuss each type as follows.General Obligation Debt
The broadest type of tax-backed debt is general obligation debt. There are two types of general obligation pledges: unlimited and limited. An unlimited tax general obligation debt (also called an ad valorem property tax debt) is the stronger form of general obligation pledge because it is secured by the issuer’s unlimited taxing power. The tax revenue sources include corporate and individual income taxes, sales taxes, and property taxes. Unlimited tax general obligation debt is said to be secured by the full faith and credit of the issuer. A limited tax general obligation debt (also called a limited ad valorem tax debt
No longer available |Learn moreSeries 7 Exam 2024-2025 For Dummies
Book + 6 Practice Tests Online
- Steven M. Rice(Author)
- 2023(Publication Date)
- For Dummies(Publisher)
Taxable Municipal Bonds Much more often than not, the interest on most Municipal Bonds is federally tax-free and some- time triple tax-free (the interest is exempt from federal, state, and local taxes). However, some Municipal Bonds are fully taxable, and some are only taxable to investors who are required to pay alternative minimum taxes (AMT). Issuers create taxable Municipal Bonds when they can’t legally create ones that are tax-exempt because the issue doesn’t meet federal tax laws to be tax exempt, such as when the bond issue isn’t for public purpose. There are a couple types that you need to be aware of for the Series 7 that are taxable. These bonds are still issued and backed by a municipality but are still taxable. These bonds were created under the Economic Recovery and Reinvestment Act of 2009 and are called Build America Bonds (BABs). The idea behind the BABs is to help municipalities raise money for infrastructure projects such as tunnels, bridges, roads, and so on. These bonds have either a higher coupon rate than most other Municipal Bonds because the municipality receives tax credits from the federal government or are more attractive because the investors receive tax credits from the federal government. As such, these Municipal Bonds become more attractive to all investors, even ones with lower income tax rates. Even though the Build America Bond program expired in 2010, there are still plenty of these bonds out there so, you will be tested on them. The two types of Build America Bonds are: » Tax Credit BABs (Tax Credit Bonds): Investors of this type of Build America Bonds receive tax credits equal to 35 percent of the coupon rate. » Direct Payment BABs (Direct Pay Subsidy Bonds): When a municipality issues Direct Payment BABs, it receives reimbursements from the U.S. Treasury equal to 35 percent of the coupon rate. As such, direct payment BABs would tend to have a higher coupon rate than tax credit BABs.
eBook - ePub- William L. Raymond(Author)
- 2018(Publication Date)
- Routledge(Publisher)
Let us examine this table. Bonds issued for general government properties, for police and fire departments, for sewers and sewage disposal and for highways obviously are issued for public purposes. About the government properties and the police and fire departments, there is no question as to general public benefit. They exist for the good of the people as a whole; and they are necessary and useful. Bonds issued in reasonable amounts for such purposes are entirely proper. As to sewers, the only question that may arise is as to whether the sewers serve, in a broad sense, the people of the whole community or the people of a certain section only. When the latter is the case, sewer bonds often are issued as special assessment bonds — that is, as bond payable out of assessments levied on abutting or benefited property and not out of taxes levied on all the property within the community. Special assessment bonds are not, strictly speaking, Municipal Bonds at all. Sewers may be considered necessary and useful purposes.Here it may be well to refer briefly to the length of time which Municipal Bonds shall have to run. In general, the bonds should not remain outstanding longer than the probable existence of the property for which they are issued. This, again, depends on the character of the property. In many communities, there has been great laxness in issuing Municipal Bonds having maturities beyond the probable life or usefulness of the work. This phase of our subject we shall take up later.Bonds issued for highway purposes are for purposes of benefit to the general public and for purposes that may be considered necessary and useful. In highway construction, two or more cities and towns may act concurrently.Charities, hospitals and corrections are public and also, within limits, necessary and useful purposes. Bonds should be issued, of course, only for buildings or other more or less permanent structures in connection with such activities.School buildings are among the very best of purposes. Under the American system of universal and often compulsory education, bonds issued for schoolhouses may be thought of as issued for a strictly public purpose and for a purpose highly useful and beneficial. Probably the people of almost any American community would struggle hard to avoid default on any obligations incurred in connection with the public school system.Libraries, art galleries and museums, and also parks and playgrounds, are to be thought of as distinctly public purposes. Such places, when created and owned by the municipalities,1
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