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Municipal Bond Types & Characteristics

Municipal Bond Types & Characteristics. Yinyin Cao. The Muni Market at a Glance. More than 50,000 state and local issuers Outstanding municipal bonds: 2.9 trillion Almost 500 billion new bonds issued each year American households are the single largest holders. Why People Buy Bonds?.

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Municipal Bond Types & Characteristics

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  1. Municipal Bond Types & Characteristics Yinyin Cao

  2. The Muni Market at a Glance • More than 50,000 state and local issuers • Outstanding municipal bonds: 2.9 trillion • Almost 500 billion new bonds issued each year • American households are the single largest holders

  3. Why People Buy Bonds? • Predictable, tax-free income stream • High degree of safety • Low default rates • Bond insurance • Low volatility • Diversification

  4. Types of Municipal Bonds

  5. Taxability • Generally tax-exempt • Taxation on acquisition, ownership, and disposition • Private Activity Bonds • Alternative Minimum Tax (AMT) • Taxable Municipal Bonds • e.g. Build America Bonds (BABs)

  6. Bond Yields

  7. Comparing Yields

  8. When Does it Make Sense to Buy Municipal Bonds? • Available Investment: $10,000 • Potential Alternatives: • 10 yr, AAA-rated municipal bond yielding 4.5%, and • Similarly rated corporate bond yielding 5.5%

  9. Corporate-Municipal Spreads

  10. Consider This… • At what marginal tax rate would an investor be indifferent between buying municipal or taxable bonds? • What interest rate on a corporate bond would you require in order to earn a better return than 4.5% on municipal bonds? • Tax Equivalent Yield (TEY)

  11. Tax Equivalent Yield • Higher tax brackets derive more benefit from munis • Changing tax rates will affect the corporate-municipal yield spread • Higher tax brackets derive more benefit from munis. • Changing tax rates will affect the corporate-municipal yield spread. • Competition with other markets increases when the economy is strong.

  12. Yield Curves • Word to the wise- Never ignore an inverted yield curve.

  13. Municipal Bonds vs. Corporate Bonds Corporate Bonds Serial maturity structure Do not require registration OTC, lower trading levels Term maturity structure More disclosure/ transparency More market liquidity Munis

  14. Other Features • Variable interest rates • Calculated periodically based upon a percentage of other interest rates • Call provisions • Permits issuer to replace debt with lower costs • Call price set at a premium • Put features • Yields are often lower • Sinking fund provisions • Reduces risk of default • Price may be lower than market price

  15. Future Outlook • Continued budget stress for some municipalities • Defaults are extremely rare • States and many municipalities are not legally allowed to file for bankruptcy • Important to understand the ample protection of municipal bonds • Supply/demand imbalances • Effect of negative headlines on retail investors • Expiration of BABs • Attractive tax equivalent income

  16. Questions? Thank You…

  17. Sources • InvestinginBonds.com http://www.investinginbonds.com/learnmore.asp?catid=8 • Investopedia http://www.investopedia.com/university/advancedbond/advancedbond4.asp • MSRB http://www.msrb.org • MunicipalBondsToday.com http://www.municipalbondstoday.com/25/municipal-bond-basics/ • Wikipedia http://en.wikipedia.org/wiki/Municipal_bond

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