Fixed Income / Bonds

Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities, which use the money to build schools, highways, hospitals, sewer systems and myriad other projects for the public good. When you purchase a municipal bond, you are lending money to a state or local government entity, which in turn promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date.

Not all municipal bonds offer income exempt from both federal and state taxes. There is an entirely separate market of municipal issues that are taxable at the federal level, but still offer a state — and often a local — tax exemption on interest paid to residents of the state of issuance.

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. Investor-led housing, local sports facilities, refunding of a refunded issue and borrowing to replenish a municipality’s underfunded pension plan are just a few examples of bond issues that are federally taxable.

The growth of the taxable municipal market in recent years has been astounding. In the last five years alone, over $134 billion in taxable municipals have been issued.

Build America Bonds (BABs) are taxable municipal bonds which resulted from the American Recovery and Reinvestment Act of 2009. The program ended in 2010. Through the BABs program, state and local governments issued bonds whose interest was taxable at the federal and state levels, except in the state where issued. Because the interest was taxable, the interest rates paid were greater than that paid for tax free municipal bonds. To offset some of the added interest cost, the federal government reimburses 35% of the interest cost paid by the issuer.

While most bonds provide semiannual interest payments, zero coupon bonds, as their name suggests, have no “coupon,” or periodic interest payments. Instead, the investor receives one payment — at maturity — that is equal to the principal invested plus the interest earned, compounded semiannually, at a stated yield. Zero coupon bonds are sold at a substantial discount from the face amount.

CMOs, also referred to as Real Estate Mortgage Investment Conduit (REMIC) are multiclass securities that allow cash flows to be directed so that different classes of securities with different maturities and coupons can be created.

The first CMO was issued in 1983. Three years later the Tax Reform Act of 1986 was passed, allowing mortgage securities to be issued in the form of a Real Estate Mortgage Investment Conduit (REMIC), which passes certain tax advantages to both issuers and investors.

Agency bonds are issued by two types of entities:

1) Government Sponsored Enterprises (GSEs), usually federally-chartered but privately-owned corporations; and
2) Federal Government agencies that may issue or guarantee these bonds to finance activities related to public purposes, such as increasing home ownership or providing agricultural assistance.

Agency bonds are issued in a variety of structures, coupon rates and maturities. In general, the agency bond market is considered a liquid market. However, some agency bond issues have features that make the bond issues more “structured” and complex, which can reduce liquidity of these investments and make them unsuitable for individual investors.

CDs are time deposits: you agree to place your funds on deposit with the bank for a stated period of time. During the term of the CD, your funds earn interest at a stated interest rate or based upon an agreed method of calculating the rate, such as the percentage increase in the stock market.

Because you agree with the bank to keep your funds on deposit for a period of time, CDs may offer you a higher rate of interest than other types of deposit accounts that allow you more immediate access to your funds, such as checking and savings accounts.

Generally, the longer you are willing to let the bank keep your funds, the higher the rate you will receive on your CD.

Most banks are members of the FDIC, a government agency that insures bank deposits. You are eligible for $250,000 of deposit insurance for all the deposits you own at one bank in each recognized ownership capacity.

In terms of total face value of bonds outstanding, the corporate bond market is bigger than each of the markets for municipal bonds, U.S. treasury securities and government agencies securities.

Corporate bonds are debts issued by industrial, financial and service companies to finance capital investment and operating cash flow. Investors in corporate bonds have a wide range of choices when it comes to bond structures, coupon rates, maturity dates, credit quality and industry exposure. There are different types of corporate bonds, including floating rate, fixed rate, and zero coupon bonds.

Convertible bonds are corporate bonds that can be converted, at the investors discretion, into the common stock of the company. Convertible bonds are issued with a set conversion ratio. Based on the price of the company’s common stock, the investor may be better off converting the bond into common stock. Because there is a conversion feature, convertible bonds typically offer a lower interest rate than similar corporate bonds.

Investors need to understand what happens if a corporate bond issuer goes bankrupt and how changes in a company’s credit rating can affect its bond investors’ yields, among many other considerations.

A debt security issued under a program that allows the issuer to offer notes continuously to investors through an agent.

The size and terms of medium-term notes may be customized to meet investors’ needs. Maturities can range from one to 30 years.