Municipal Bonds

Whether you are an investor or not, you have probably heard of municipal bonds. The purpose of this post is to provide the reader with general educational information about this type of investment. Please keep in mind that any information contained herein is for educational purposes only and should not be considered as legal or investment advice. You should consult an experienced professional, if you have any questions concerning anything that you read on this page.

A municipal security is a negotiable bond or note issued by a United State’s state or subdivision thereof. A municipal bond may be a general obligation backed by the full faith and credit (i.e., the borrowing and taxing power) of a government; a revenue obligation paid out of the cash flow from an income producing project; or a special assessment obligation paid out of taxes specially levied to finance specific public works.

Municipal bonds come in a few different types, including the following:

• General obligation bonds — The issuer backs up the interest payments on these bonds by taxation. Known as GOs, these bonds are voter approved, and the principal is backed by the full faith and credit of the issuer.
• Revenue bonds — These bonds are usually issued to fund a specific project such as a highway. The revenues collected from tolls, charges or in some manner from the project will be used to pay interest to the bond holders. Unless otherwise specified in the indenture, holders of these bonds have no claims on the issuer’s other resources. If the revenue bond has a sinking fund associated with it, it is usually disclosed on the confirmation.
• Moral obligation bond — A moral obligation bond is a tax exempt bond issued by a municipality or a state financial intermediary and backed by the moral obligation pledge of a state government. (State financial intermediaries are organized by states to pool local debt issues into single bond issues). Under a moral obligation pledge, a state government indicates its intent to appropriate funds in the future if the primary obligor, the municipality or intermediary defaults. The state’s obligation to honor the pledge is moral rather than legal because future legislatures cannot be legally obligated to appropriate the funds required.
• Taxable municipal bond — There are situations in which a governmental issuer will sell taxable municipal bonds because the federal government will not subsidize the financing of certain activities that do not provide a significant benefit to the general public. Investor-led housing, local sports facilities, refunding of a refunded issue and borrowing to replenish a municipality’s underfunded pension plan are just four examples of bond issues that are federally taxable. Taxable municipals offer yields more comparable to those of other taxable sectors, such as corporate bonds or bonds issued by U.S. governmental agencies, than to those of tax-exempt municipals.
• Variable-rate bonds — The interest rate of these bonds is calculated periodically, and is typically based upon a percentage of prevailing rates for treasury bills or other interest rates.
• Put bonds — Some bonds have a “put” feature that allows you to sell the bond at par value on a specified date long before its maturity date and recoup the principal and accrued interest. Many times put bonds come with lower than average yields in exchange for this option.
• Zero-coupon bonds — These types of bonds can be issued by companies, government agencies and municipalities. They are issued at a deep discount to the maturity value and do not make periodic interest payments. At maturity, an investor will receive one lump-sum payment at maturity equal to principal invested, plus interest compounded semiannually at the original interest rate. Please note that there are unique tax considerations associated with these types of bonds.
• Insured municipal bonds — Some municipal bonds are backed by municipal bond insurance specifically designed to reduce investment risk. In the unlikely event of payment default by an issuer, an insurance company, which guarantees payment, will send you both interest and principal when they are due.

As with any investment, there are numerous risks associated with bonds, including call risk, credit risk, inflation risk, interest rate risk and liquidity risk. Consequently, when discussing these types of investments with your account executive or other financial professional be sure that you fully understand these and any other risks disclosed to you by your financial professional.

Keep copies of any information that is provided to you by your financial professional and make notes of your conversations, with your account executive, leading up to your decision to purchase so that you can refer back to this information if there is a problem. Additionally, if you do elect to purchase a bond, keep notes of any subsequent conversations that you might have relative to the investment. If these subsequent conversations do not comport with what was said to you as inducement for the purchase, you should immediately seek professional assistance.

For additional information concerning municipal bonds and the municipal bond markets, please follow the highlighted links. Also, if you have any questions concerning the Municipal Securities Making Board do the same.

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