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Investing in Special Type Bonds, Taxable Municipal Securities & Short-Term Obligations

Instructor: LeRoy Rands

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

Municipal bonds are a trillion-dollar market. Most municipal bonds are general obligation or revenue bonds, but this lesson is going to discuss some unique types of municipal bonds and notes.

Municipal Bonds

Sally specializes in municipal bonds for ABC Financial. She is particularly interested in marketing some of the unique types of municipal bonds and notes to her clientele. However, she knows she needs to educate them about the advantages of these unique securities.

The municipal bond market is huge, with trillions of dollars of outstanding issues. This is where state, city and county governments raise the capital they need that is beyond their current tax revenues. The two major types of municipal bonds are:

  • general obligation bonds, which are paid back from future revenues of the issuer
  • revenue bonds, which are issued to finance a particular project and are repaid from the revenues generated by that project

This lesson will discuss some types of municipal bonds and notes that are less commonly known and the benefits of investing in those types of securities.

Taxable Municipal Bonds

Sally wants to get some of her customers interested in taxable municipal bonds. She feels they will have some advantages for some investors.

Taxable municipal bonds are bonds issued for some type of development that doesn't qualify for a tax exemption for federal tax purposes. For a municipal bond to be non-taxable, the bond must be issued for a purpose that will benefit the whole community.

As an example, Bountiful County might issue a taxable municipal bond to assist a company in relocating to their county and building a facility that will create 1,000 jobs for the county. The county plans to repay the bond through taxes on the company's sales, as well as increased sales taxes and property taxes.

There are many advantages to investors from investing in taxable municipal bonds, including:

  1. The interest or coupon rate on the bonds, although not tax exempt, is competitive with interest rates on corporate bonds.
  2. The bonds are secured by a municipal government that can't just declare bankruptcy like a company. There is also ongoing revenues to back the bonds.
  3. Although not exempt from federal taxes, the income might still be exempt from state income taxes.

Special Tax Bonds

Special tax bonds are issued by municipalities for a particular purpose, with the bonds being paid back by a specific tax or fee on that service. For instance, Sally likes a bond being issued by Bountiful County to build a new cancer center at the public hospital that will be repaid from local taxes on cigarettes.

Some of the advantages to investors for investing in special tax bonds are:

  • Like revenue bonds, the bonds have specific taxes or fees that will repay the bonds.
  • Interest on these bonds is exempt from income taxes.
  • The bonds are still secured by the credit standing of the issuing municipality.

Special Assessment Bonds

Special assessment bonds are a variation of special tax bonds. Instead of being paid back from fees or taxes on the whole community, special assessment bonds are paid back from fees assessed on the particular homeowners receiving benefits from the project.

For instance, Helen knew of a special assessment bond in Bountiful County that was issued to redo all the concrete sidewalks in a particular subdivision. The fees to pay the interest and pay back the principal was assessed on the homeowners in that subdivision.

Special assessment bonds have the same advantages as special tax bonds, and they are guaranteed by the municipality that is issuing the bonds. It is one thing for a private company to declare bankruptcy, liquidate and go out of business. A municipality has thousands of constituents who are still depending on services, so the government must honor its debts and find ways to work out problems if it gets in financial trouble.

Municipal Notes and Bills

Short-term municipal notes and bills are issued by governmental bodies for a couple of reasons.

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