- What are municipal
bonds?
Municipal bonds are securities issued by state and
local governments, their agencies, and/or political
subdivisions to finance public improvement projects.
The bond issuer borrows needed money by selling municipal
bonds. The investors who buy municipal bonds become
creditors and are essentially loaning money to the
issuer to fund public projects. Each bond is, in effect,
an IOU representing the issuer's promise to repay
the borrowed amount in a stated period of time. In
exchange for the use of the money, the issuer usually
also makes interest payments to the bondholders until
the bonds are repaid.
- What is meant
by tax exemption?
Traditionally, municipal bond's principal and interest
are exempt from federal income taxes under section
103(a)(1) of the Internal Revenue Code. In addition,
they are often exempt from the income taxes of the
state and locality in which the issuing municipality,
political subdivision or agency is located.
Interest paid on bonds issued by the City of New York
are triple tax-exempt for residents of the City.
This means the interest is exempt from federal, state,
and city income taxes.
- Are municipal
bonds for me?
Tax-exempt bonds are not necessarily a suitable investment
for everyone. The extent of their suitability depends
on one's income, tax bracket, investment objectives
and other factors. Therefore, prior to buying municipal
bonds, one should consult with a qualified tax or
investment advisor.
- What are the types
of municipal bonds?
Municipal bonds vary by the type of security pledged
for repayment. Among the most common are the following:
General Obligation
Bonds:
General obligation (GO) bonds are backed by the
issuer's pledge of its full faith, credit and taxing
power for the payment of the bond. GOs are generally
viewed as the most secure type of municipal security
and typically finance public projects such as schools,
parks, libraries, roads and city halls.
Revenue Bonds:
Revenue bonds are payable from revenue derived from
tolls, charges, fees or rents paid by those who
use the facilities constructed with the proceeds
of the bonds. For example, a water revenue bond
would typically be payable from water charges and
other revenues of the water system.
Variable Rate
Demand Bonds:
Commonly called "floaters," variable rate
demand bonds are long-term municipal bonds that
act like short-term notes because they reflect short-term
interest rates and offer short-term liquidity. They
are typically secured by an irrevocable letter of
credit from a domestic or foreign bank or a bond
insurer with a liquidity facility from a domestic
or foreign bank.
Housing Revenue
Bonds:
Housing bonds are payable from mortgage loan payments
and may be additionally secured by various types
of insurance and/or state, federal or local support
programs.
Special Tax Bonds:
Special tax bonds are payable only from the proceeds
of a special tax, such as highway bonds payable
solely from a gasoline tax.
Lease Revenue
Bonds:
Similar to COPs, lease revenue bonds are also secured
and payable from lease rental payments made by a
municipal entity. Examples: parking lots, office
buildings.
Certificates
of Participation:
Certificates of participation, or "COPs"
as they are commonly known, are typically secured
and payable from lease rental payments made by a
municipality for use of projects being financed
with the COPs. Examples: computer equipment, fire
engines, police cars.
- Who buys municipal
bonds?
Individual investors, pension funds, mutual fund companies,
insurance companies, and other corporations all buy
municipal bonds.
- What are the key
advantages of municipal bonds?
Tax-Exempt Income:
The one characteristic that sets municipals apart
from other securities is that the interest they earn
is exempt from federal income taxes. And, the interest
is often exempt from state income taxes of the state
in which the issuing municipality or agency is located.
This tax-exemption feature can be especially attractive
to investors in higher tax brackets. Interest payments
on tax-exempt municipals are generally lower than
on taxable investments with comparable credit quality
ratings and maturities. But because the federal government
does not tax the interest, individuals in high tax
brackets may receive a higher after-tax yield from
a tax-exempt bond than from a taxable one.
The advantage of
investing in tax-exempt municipal bonds is best
described by comparing what a taxable investment
would have to yield after taxes in order to match
the tax-free returns offered by municipal bonds
on a taxable equivalent basis.
Low Credit Risk:
High-quality municipals are considered a conservative
investment because their interest and principal
payments are considered quite secure. Even though
the issuer promises to pay the full amount of the
bond when it matures or comes due, there may be
interim fluctuations in the bond's market price
before it reaches maturity. Municipal bonds offer
a degree of safety that is comparable to U.S. government
obligations
Flexibility:
Maturity dates on municipal securities can range
from several months to 40 years or more. Investors
can decide when they want their principal returned
allowing them to tailor their investment horizon.
Diversity:
The municipal market is one of the most diverse
of all the fixed-income markets in terms of numbers
and types of bonds. There are general obligation
bonds secured by the full faith and credit of a
state or local government, as well as revenue bonds
backed by revenues from a particular project, such
as a toll road or bridge. There are also special
kinds of municipals issued to meet particular investor
needs. These include alternative minimum tax (AMT)
municipals, often offering higher tax-free yields
for investors who are not subject to the AMT, refunded
municipals and insured municipals for safety conscious
investors and zero-coupon municipals, offering investors
an assured way to increase a sum of money provided
the bonds are held to maturity.
With the wide variety
of issuers and types of bonds available today, it
is easy to diversify your investments. Your tax
advisor or a qualified broker can help you determine
the most effective way to structure your portfolio
-- and balance risk and reward.
Marketability:
Municipal Bonds are actively traded nationwide through
a network of broker-dealers and dealer-banks, providing
a fairly liquid market. If you sell bonds prior
to maturity, you will receive the current market
price, which may be higher or lower than the original
price.
- What are the
risks in owning fixed income securities?
Credit Risk:
Credit risk is the risk that an issuer will be unable
to make scheduled interest and principal payments.
Rating agencies review the issuer's ability to make
interest and principal payments and assign a rating
as to the issuer's credit worthiness. The higher
the rating, the less risky the security, and conversely,
the lower the rating, the more speculative the security.
Bond rating agencies continuously review the credit
worthiness of each issuer and the assigned ratings
can change. A change in rating may affect the price
of the security.
Market Risk:
Market risk is the risk that you
might have to sell your security at a loss prior
to maturity. As interest rates rise, the price of
your bond may decrease, meaning you would suffer
a loss if you sold the bond prior to maturity. Conversely,
when interest rates fall, the price of your bond
may increase, and you might receive a profit if
you sold. If an investor holds a bond until its
maturity market risk is not a factor.
Call Risk:
Many U.S. agency, municipal and
corporate bond issues have provisions which allow
the issuer to call, or redeem, all or a portion
of their outstanding bonds prior to maturity. This
call feature, known as an optional call, may be
at a premium or at par and may occur even prior
to the stated redemption dates. When interest rates
fall, an issuer may opt to call bonds and refinance
the project at the prevailing lower interest rates.
Depending on the price you paid for your bonds,
this could affect your yield. In addition to optional
call features, some issues such as municipal housing
bonds have special redemption calls. Should the
issuer have excess funds due to prepayments or unexpected
proceeds, these funds must be used to redeem outstanding
bonds. These types of calls can occur at any time,
are par calls and may affect the yield you receive.
Duration Risk:
Duration is a calculation which takes into account
the maturity date, coupon rate, and yield on a bond.
The duration figure will give you a close approximation
of how much a bond's price will change for each
percentage change in interest rates. Generally speaking,
the longer the term to maturity the greater the
potential the price will fluctuate in response to
interest rate movements. The fixed coupon rate of
a bond also affects how much the price of a bond
will fluctuate. The lower the coupon rate, the more
volatile the price of the bond will likely be.
- Can I purchase
bonds directly from the City?
No. Municipal bonds sold by the City can be purchased
from registered broker-dealers nationwide.
- My bond matured
at least 6 months ago and I was unable to redeem it.
Do I earn interest on principal for the period during
which I did not redeem my bond?
No. Interest earned on unredeemed principal and/or
interest becomes property of the City. The investor
will only receive the stated principal and/or interest
amount stated on the bond. It is incumbent upon the
investor to present the bond for payment/redemption
in a timely manner to the City's Fiscal Agent.
- How do I redeem
bonds that matured more than 3 years ago?
The proceeds on bonds which have matured more than
three years ago, have been escheated to the New York
State Comptroller's Office of Unclaimed Funds. The
bondholder should contact that office to begin the
claim process at the following:
New York State Comptroller
Office of Unclaimed Funds
110 State Street
Albany, New York 12236-0001
(800) 221-9311
- How are municipal
securities rated?
The three major rating agencies
that evaluate municipal credit are Moody's Investors
Service, Standard & Poor's Corporation (S&P),
and Fitch Investors Service. They research the issuer's
ability to repay debt and then assign a rating symbol
which ranks the quality of the bonds. The chart
below describes the rating symbols used for bonds
and notes.
Bonds
|
Moody's
|
S&P
|
Fitch
|
Definition
|
| Aaa |
AAA |
AAA |
Highest quality;
extraordinary ability to repay principal
and interest. |
| Aa |
AA |
AA |
High quality; very
strong capacity to repay. |
| A |
A |
A |
Upper medium grade
quality; strong capacity to repay. |
| Baa |
BBB |
BBB |
Medium grade quality;
adequate capacity to repay. |
| Ba |
BB |
BB |
Speculative; repayment
protection moderate. |
| B |
B |
B |
Highly speculative;
lightly protected. |
| Caa |
CCC |
CCC |
Of poor standing;
possibility of default |
| Ca |
CC |
CC |
Minimally protected;
default probable. |
| C |
C |
C |
In actual or imminent
default |
| D |
D |
|
In default |
Bond ratings listed
above the line are considered "investment grade."
Those below are considered speculative or "below
investment grade."
Notes
| Moody's |
S&P
|
Fitch |
Definition |
MIG1
/VMIG1 |
SP-1+
|
F-1+ |
Best quality;Strong
protection by established
cash flows, superior liquidity support or
broad-based access to the market for refinance. |
|
SP-1
|
F-1 |
Very strong or strong capacity
to pay
principal and interest. |
MIG2
/VMIG2 |
|
|
High quality.Margins of protection
are ample. |
|
SP-2
|
F-2
|
Satisfactory capacity to pay
principal and
interest. |
|
MIG3
/VMIG3
|
|
|
Favorable quality. All security
elements are
accounted for but without the strength of
higher grades. Liquidity and cash flow
protection may be narrow.Market access for
refinancing likely to be less established. |
|
SP-3
|
F-3 |
Speculative capacity to pay
principal and
interest |
MIG4
/VMIG4 |
|
|
Adequate quality. Required protection
is present. Although no distinctly or predominantly
speculative,
there is specific risk |
- What are insured
municipal bonds?
Municipal bond insurance is an unconditional guaranty
by a third party, a bond insurance company, to make
timely payments of principal and interest to bondholders
in the event the municipal issuer of the bonds, for
whatever reason, is unable to do so.
- What are the
key advantages of municipal bond insurance?
Safety:
Timely payment of principal and interest on insured
bonds is unconditionally guaranteed by the bond
insurer. The major bond insurers are all rated in
the top rating category -- AAA -- by Moody's Investors
Service and/or Standard & Poor's Corp and Fitch
Investor Service. However, as is usually the case
with a safer investment, AAA insured municipal bonds
typically offer a lower return than bonds which
carry a AAA without insurance.
Liquidity:
Insured municipal bonds typically trade more on
the strength of the insurer than on the underlying
municipality, and an active secondary market exists
for insured municipal bonds. Thus, there is high
degree of liquidity even for small or unfamiliar
municipal issues which are backed by bond insurance
from one of the major insurers.
Marketability:
Municipal bond insurance increases the marketability
of many bond issues, particularly those with more
complex security structures or unfamiliar names.
- How safe are
the municipal bond insurers?
Municipal bond insurers only guarantee bonds which
meet their credit standards. Generally this means
that the bonds must be of at least investment grade
quality, or not lower than a Baa or BBB -- equivalent
in quality.
The primary municipal
bond insurance companies maintain the highest credit
ratings from the major ratings agencies. These insurance
companies include:
AMBAC Indemnity
Corporation (AMBAC)
Capital Guaranty Insurance Company (Capital Guaranty)
Financial Guaranty Insurance Company (FGIC)
Financial Security Assurances, Inc. (FSA)
Municipal Bond Investors Assurance Insurance Corporation
(MBIA)
- Why is bond insurance
used?
There are three major reasons why municipal bond insurance
is utilized by issuers or underwriters:
Reduce the issuer's
cost of capital/borrowing costs:
An issuer's interest costs are significantly reduced
since bonds which are guaranteed by one of the major
municipal bond insurers automatically receive a
AAA rating and a higher rating generally means a
lower borrowing cost. Generally, a cost/benefit
analysis is done by the issuer, financial adviser
or underwriter to determine whether the interest
cost savings outweigh the cost of the insurance
premium.
Increase marketability:
Municipal bond insurance increases the marketability
of many bond issues, both at the time of original
issuance and in the secondary market.
Enhance security:
As mentioned above, the major bond insurers are
all rated in the top rating category (AAA) by one
or more of the major credit rating agencies. Thus,
the security of a lower-rated bond issue can be
significantly enhanced by obtaining a bond insurance
guaranty.
- What are the
risks associated with municipal bond insurance?
Although bond insurance protects investors against
credit risk, it does not protect the market value
of bonds. If an investor's insured bonds are sold
prior to maturity, the insurance policy does not guarantee
that the selling price will be equal to par - it may
be above or below par depending on market conditions.
Bond insurance only guarantees the scheduled payment
of interest and principal at maturity.
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