Baa, Baa, Black Sheep (Municipal Bonds)

By: Eric Peters, Fall 2017 IAC Student Intern

Munis, Munis,

Loaning to the State,

City, local, county,

Funding all they make.

Short term, long term,

A couple years or ten!

Tax exemptions,

It’s a win-win.

 

Steady income,

Typically low rates,

Great for all your hedging,

Risk aversion’s great!

General obligation,

Or revenue bonds,

Some non-recourse,

When income’s gone.

 

Backed by the government’s

Ability to tax,

Full faith and credit,

Giving what they’re tasked.

 

Five types of risks,

They’re stable, but refrain,

From putting too much confidence,

In State projects and gains.

 

Brokers charge fees,

On selling all these bonds,

Broker Check from FINRA,

Registering’s a must.

 

Knowledge is power,

Check out what you must.

Disclosure statements posted,

On EMMA, who you’ll trust.

Learn More:

  • Municipal bonds are debt securities issued by states, cities, counties, and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools, highways, or sewer systems
  • Short Term Municipal Bonds à 1-3 years
  • Long Term Municipal Bonds à > 10 years
  • Generally, the interest you receive on municipal bonds are tax-exempt from federal income tax
    • They also may be exempt from state and local taxes if you reside in the State the bond was issued in
  • Provides a steady stream of coupon payments
  • Because of the tax benefits, the interest rate for municipal bonds is usually lower than other taxable, fixed-income securities such as corporate bonds
  • 2 Most Common Types:
    • ) General Obligation Bonds à issued by States, cities, or counties and NOT secured by any assets
      • They are backed by the full faith and credit of the issuer (an entity that has the power to tax)
    • ) Revenue Bonds à NOT backed by government’s taxing power, but by revenues from a specific project or source (highway tolls, lease fees, etc.)
      • Some are non-recourse, meaning that they have no recourse if the income stream dries up (the bondholder has no claim on the underlying revenue source)
    • Go to https://emma.msrb.org/Home to get more information on different municipal bonds
      • Provides disclosure statements (similar to a prospectus) and historical and real-time transaction price data
    • Types of Risk Associated with Municipal Bonds:
      • Call Risk à the potential for the issuer to repay a bond before its maturity date, resulting in the immediate payment of all interest payments due
        • Issuers are more likely to call a municipal bond when interest rates are low
      • Credit Risk à the risk that the bond issuer may experience financial problems and default on payments
      • Interest Rate Risk à municipal bonds have either fixed or floating interest
        • If you have a fixed interest rate, you may miss out on better rates for the money you put in the municipal bonds
        • If you have a floating interest rate, rates may sink and you will be stuck with a lower rate, instead of being locked into a better one
      • Inflation Risk à If inflation pushes the interest rates up after you lock into a fixed rate, you may miss out on the higher rates
      • Liquidity Risk à These bonds have an illiquid market because most people hold on to their bonds until maturity à so, if an investor wishes to buy or sell municipal bonds, it’s very hard to do so
    • Brokers charge fees on selling these bonds
      • Check if these brokers are registered with the SEC
      • Go on FINRA’s BrokerCheck website to check any potential broker out.

If you want to learn more about municipal bonds, check out the following websites:

https://www.sec.gov/oiea/investor-alerts-bulletins/investor-alerts-municipalbondshtm.html

https://www.investor.gov/introduction-investing/basics/investment-products/municipal-bonds