Bonds, bonds and more bonds

Digging just a little bit deeper on the subject of bonds.

In my past articles I have gone over corporate bonds, municipal bonds, agency bonds, and Government bonds in one form or another, so now it’s time to dig a bit deeper. Let’s begin with my favorite, municipal bonds, or munis for short.

There are a number of types of muni bonds out there for you to invest in so let’s go over a few. To you and I, all munis are somewhat the same; we get a safe tax free source of income. The difference lies in the creation of those bonds. When you look more closely you find there are a number of different types of bond issues: RANs’, TAN’s, GO’s, Revenue Bonds, Housing Bonds, and the list goes on. So, let’s cover a few of these.

General obligation bonds: Principal and interest payments are backed by the full faith and credit, and the general taxing powers of the issuer.   The issuing municipality promises to levy enough taxes to meet its obligations to pay principal and interest in a timely manner.

Revenue bonds: Principal and interest payments are secured by revenues from the project being financed. These bonds are not backed by the issuers taxing authority so they are deemed more risky. Of course you have to put that in prospective. They are risky; however we are talking about muni bonds here, many of which are insured, so your real risk is very low.

Municipal notes: These are short term debt obligations that mature in a year or less and are used to generate a stable cash flow until they receive other expected revenues. They are traded in larger blocks, usually $100,000 and more.

Housing bonds: These bonds are backed by mortgages and mortgage loan repayments. These bonds can be called at any time and are more likely to be called when rates are dropping and people are paying off their higher rate loans. These bonds do not adhere to any all features.

Original issue bonds (OID’s): These bonds are issued at a deep discount. The difference between the issue price and par is treated as tax exempt income.

Refunded bonds:  Some municipal securities originally issued as straight general obligation or revenue bonds may become refunded. When a security is refunded, it is escrowed or collateralized by either U.S. government treasury securities or some other types of securities. The securities in the refunding escrow fund are set up so they mature when interest, principal and premium payments are due. Refunded bonds are considered one of the safest municipal securities available.

Pre-refunded bonds: Pre-refunded bonds are refunded bonds that are scheduled to be called on the first possible call date or a subsequent date as outlined in the bond's indenture. This structure is typically used to reduce the interest payment expenses for the issuer.

Escrowed-to-maturity bonds: Some refunded bonds are not scheduled to be called. These securities, known as escrowed-to-maturity (ETM) bonds, are backed by escrow funds designed to make payments as outlined in the security's original indenture.

And there you have it; just a little more information about municipal bonds. Before purchasing tax free munis make sure you check with you financial advisor so they can run the calculation against taxable bonds to see which one really has the highest yield. For those of you in retirement, or those whose income is relatively low may find that taxable bonds are the best way to go.

Good luck and Happy Investing.

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