US Municipal Bonds

US Municipal Bonds

An investor invests all or part of his investments in different kind of bonds with the objective of safety. US Municipal Bonds are very popular with investors in the U.S. These bonds are issued not by the U.S. Government but by corporations running public utilities and infrastructure facilities, local government boards such as those of counties, cities and towns. 

US Municipal Bonds are primarily debt instruments issued for more than a year. Instruments issued for less than a year are called ‘notes’. The interest on municipal bonds is usually paid once in 6 months. The purpose of US Municipal Bonds is to collect money for the purpose of capital expenditure such as construction of roads, schools, bridges, and installation of systems like water and sewerage. Sometimes these bonds are also issued for collecting funds for a temporary purpose.

Investors Preference of US Municipal Bonds Over Corporate Bonds

The interest from US Municipal Bonds is usually tax exempt. So the investor manages to get a higher return on his investment though the interest rate is lower.

US Municipal Bonds are also considered to be a safer investment than corporate bonds. However these bonds are not entirely safe and there have been cases of defaults even on them.

Types of US Municipal Bonds: 

US Municipal Bonds can mainly be classified as General Obligation Bonds and Revenue Bonds.

General Obligation Bonds:

These bonds are unsecured and purchased in good faith from organizations like city corporations and town municipalities who have powers to collect taxes. Investors buy these bonds sure that the issuing entity can make regular payments to them from their tax collections.

Revenue Bonds:

These bonds are secured by specific revenues to be received by the issuing organizations from tolls, rents, or fees which they will collect from users, after completing the project for which the bonds where issued. 

Various Bonds:

Zero Coupon Bonds:  

These bonds are also called capital appreciation bonds. There are no interest payments on them. Instead, the investment appreciates in value and on maturity the investor is paid a lumpsum.

Private Activity Bonds:

Sometimes money collected from the issue of US Municipal Bonds maybe used for the full or part benefit of a private entity. Such bonds are usually taxed. In the case of Qualified Private Activity Bonds, the money may benefit a private party but will also serve the common good. These may not be taxed.

Fixed interest Bonds and Variable Interest Bonds:

Though US Municipal Bonds are basically Fixed Interest Bonds some of them may offer variable rates of interest. 

Risks associated with US Municipal Bonds:

Credit risk:

As mentioned earlier, these bonds are not completely safe and have an element of risk in them. Rating agencies such as Moody’s and Fitch rate these bonds and investors base their investment decision on these ratings. The higher the rating, the lower the risk.

Interest Rate Risk:

US Municipal Bonds usually mature after a long period of time and the rate of interest is normally predetermined. The investor loses out when the market offers higher rates of interest. However he gains when the market rates are lower than the rate which the bond offers.

Call Risk:

Though the maturity date of a bond is specified at the time of issue, the issuing organization may decide to make a call i.e. it may prepay the principal amount along with the accrued interest to the bond holder. While the investor will not lose any money, the regular income which he would have earned in the form of interest will stop.

A person wishing to buy US Municipal Bonds can buy them from the primary market that is directly from the issuer or from the secondary market that is from existing bond holders. 

These bonds benefit society, as the money raised from their issue is used for the benefit of the public.