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Municipal Bond Basics

From Your GMS Bond Specialists

Bonds are debt securities, which is similar to an I.O.U. When an investor purchases a bond, they are lending money to a government, municipality, corporation, federal agency or other entity known as an issuer. In return, the issuer provides the investor with a bond in which it promises to pay a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures.

There are various types of bonds that are available for investment including U.S. government securities, municipal bonds, corporate bonds, mortgage- and asset-backed securities, federal agency securities and foreign government bonds.

Investing in Municipal Bonds and Key Considerations

Bonds typically pay interest semiannually, which means they can provide a predictable stream of income. Whether an investor is saving for their children’s college education or a new home or increasing retirement income, there are many reasons why individuals invest in bonds.

There are a number of investment considerations to keep in mind when purchasing a bond, including;

  • Risk assessment – All investments carry various degrees of risk. With bonds, the risk profile typically consists of price, interest rate, yield, maturity, redemption features, credit risk, credit ratings and tax status.

  • Price – The price you pay for a bond is based on a number of variables, including interest rates, supply and demand, liquidity, credit quality, maturity and tax status.

  • Interest rate–Bonds pay interest that can be fixed, floating or payable at maturity.

  • Maturity – A municipal bond’s maturity refers to the date on which the investor’s principal will be repaid. Generally, bond terms range from one to 40 years. The choice of term varies on several factors; when an investor wants invested principal repaid, desired current return, risk tolerance and market conditions. Maturity may not be a factor for investors seeking maximum income.

  • Redemption features - While the maturity date indicates how long a bond will be outstanding, many bonds are structured in such a way so that an issuer can call the bond prior to maturity.

  • Call provision – Municipal bonds may have a redemption – or call – provision that allows or requires the issuer to redeem the bonds at a specific price and date before maturity. A call provision offers protection to the issuer.

  • Put provision – Can be a mandatory or optional opportunity to put the bond back to the insurer on a given date prior to maturity.

  • Principal payments and average life – Certain bonds that have a sinking fund are priced and traded on the basis of their average life rather than their stated maturity.

  • Yield – A bond’s yield is the return earned on the bond at maturity, based on the price paid and the interest payment received. Yield is quoted in basis points, or bps. There are two important types of bond yields; current yield and yield to maturity.

  • Default – This is the failure or a bond issuer to pay principal or interest when due. A technical default can occur for failure to meet obligations unrelated to payment of principal or interest, such as reporting requirements, or when a material problem occurs for the issuer (such as bankruptcy).

  • Credit quality – There is an array of credit quality choices available in the bond market ranging from the highest credit quality – Treasury bonds – to bonds that are considered to be below investment-grade. An investment grade rating is BBB or higher.

  • Credit ratings – Major rating agencies (such as Moody’s Investors Service, Standard & Poor’s Corporation and Fitch Ratings) assigns its ratings based on analysis of the issuer’s financial condition and management, economic and debt characteristics and the specific revenue sources securing the bond. The highest ratings are AAA. Credit ratings should be used as a guideline not a deciding factor to buy or sell a bond.

  • Bond insurance –Bond insurance is purchased by the issuer or underwriter and provided by a specialized insurance firm that guarantees the timely payment of principal and interest on bonds.

  • Tax status–Some bonds offer special tax advantages. Interest from U.S. Treasury bonds is not subject to state or local income tax. Most municipal bonds are tax-free. There are also numerous taxable bonds.

Learn more about investing in bonds by putting a municipal bond specialist to work for you. THE GMS GROUP bond specialists have the knowledge, expertise, research and resources to provide you with the best bond offerings for your portfolio. Contact us today for more information or call 877-467-0070.