OSU BA 441 - Municipal Bond Types and Characteristics Final

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Slide 1ContentsSlide 3Slide 4Characteristics of Muni BondsSlide 6Slide 7Slide 8Slide 9Slide 10Slide 11PaybackRetirementCurrent IssuersMuni Bond MarketsVolumeInsured Bonds In TroubleInsured Bonds in Trouble Cont’dSummaryQuestion/AnswerAround The World Trivia: Municipal Bond EditionMUNICIPAL BOND TYPES AND CHARACTERISTICSBy Sean Hutchens and Jun ParkContentsMunicipal BondsHistory of Municipal BondsCharacteristics of Muni BondsTypes of Muni BondsBond RatingMuni Bond Tax IssuesTax-freePaybackRetirementCurrent IssuersMuni Bond MarketsVolumeInsured Bonds in TroubleSummaryQuestion/AnswerGameMunicipal BondsIn the United States, a municipal bond (or muni) is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds include: Cities CountiesSchool districtsPublicly owned airports and seaports Any other governmental entity (or group of governments) below the state level.History of Municipal BondsMunicipal bonds were first issued by New York City in 1812.In 1902, outstanding state and local government debt was $2.1 BillionBy 1927, the amount of debt had jumped up to $14.9 BillionPost-depression government spending slowed progression until about 1981 when $361 Billion worth of munis were outstanding, which an increase of six-fold over 1960 which saw $66 BillionBy 2007, about $2.3 trillion in municipal bonds were outstanding, sold by more than 60,000 issuers.Characteristics of Muni BondsFederal tax exemptPay lower interest compared to corporateHave high degree of safetyGive dependable incomeTypes of Muni BondsG.O Bonds (General Obligation).Long-term borrowing in which the state issues municipal securities and pledges its full faith and credit to their repayment.@ex: school bonds, city hall bonds, library bonds, etc…..Low default rate Backed by the GovernmentDoes not generate profitTypes of Muni Bonds Cont’dRevenue BondsRepayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds.ex: toll roads, airports, water/sewer, hospitalsHigher interest rates than G.O bondsNot as safe as G.O bondsSelf-liquidatingBond RatingBond rating: A grade given to bonds that indicates their credit quality. Private independent rating services such as Standard & Poor's, Moody's and Fitch provide these evaluations of@a bond issuer's@financial strength. The bond rate for a state is determined by tax rates.Muni Bond Tax issuesMunicipal bonds are exempt from federal taxesFederal bonds are exempt from state taxesIf an investor resides within the same state in which the municipal bonds were issued, the investor is exempt from state taxes as well as Federal taxesCorporate bonds have no tax-free provisionTax-freeOregon investorCity of CorvallisNike Out-of-State Municipality*Bond Rate*Initial Investment*Annual Income6%$100,000$6,0008%$100,000$80007%$100,000$7,000*Fed Tax 25% $0 $2,000 $0*State Tax 9% $0 $720 $630*Final Income $6,000 $5,280 $6,370Oregon Tax-free Yields and Estimated Taxable Equivalent Yields- 2009 Tax YearFederal Tax Bracket 15% 25% 28% 33% 35%Taxable Income Single Return$8,350 - $33,950$33,951 -$82,250$82,251 -$171,550$171,551 -$372,950 $372,951 +Taxable Income Joint Return$16,700 - $67,900$67,901 - $137,050$137,051 - $208,850 $208,851 - $372,950 $372,951 +Federal and State Combined Tax Bracket 22.65% 31.75% 34.48% 39.03% 40.85%Oregon Tax-free YieldsFor a given Federal Tax Bracket, a Fully Taxable Bond would need to yield this or more to provide the same or greater after-tax income as an Oregon tax-free bond.1.00% 1.29% 1.47% 1.53% 1.64% 1.69%1.50% 1.94% 2.20% 2.29% 2.46% 2.54%2.00% 2.59% 2.93% 3.05% 3.28% 3.38%2.25% 2.91% 3.30% 3.43% 3.69% 3.80%2.50% 3.23% 3.66% 3.82% 4.10% 4.23%2.75% 3.56% 4.03% 4.20% 4.51% 4.65%3.00% 3.88% 4.40% 4.58% 4.92% 5.07%3.25% 4.20% 4.76% 4.96% 5.33% 5.49%3.50% 4.52% 5.13% 5.34% 5.74% 5.92%3.75% 4.85% 5.49% 5.72% 6.15% 6.34%4.00% 5.17% 5.86% 6.11% 6.56% 6.76%4.25% 5.49% 6.23% 6.49% 6.97% 7.19%4.50% 5.82% 6.59% 6.87% 7.38% 7.61%4.75% 6.14% 6.96% 7.25% 7.79% 8.03%5.00% 6.46% 7.33% 7.63% 8.20% 8.45%5.25% 6.79% 7.69% 8.01% 8.61% 8.88%5.50% 7.11% 8.06% 8.39% 9.02% 9.30%5.75% 7.43% 8.42% 8.78% 9.43% 9.72%6.00% 7.76% 8.79% 9.16% 9.84% 10.14%Muni Rate = Corp Rate x (1 – Tax Bracket)PaybackFunding generated through project revenue or taxationA muni generally pays interest semi-annuallyInterest rate lower than corporate bondsPrincipal repaid upon retirement of bondMost muni bonds are retired before maturityRetirementMany munis are serial bonds, which means that a certain percentage will be retired each year after issuance so that the municipality can minimize interest rate riskRetired bonds chosen based upon serial numberCallable nature makes munis an uncertain investment with respect to payback dateCurrent IssuersMuni Bonds are issued by states, local governments, and associated agencies such as the police department, fire department, health department, etc.Use municipal bond issues to fund capital projects and other operations for which they (municipalities) want to delay paymentDue to tax-exempt status, muni bonds allow local governments to issue debt at relatively low borrowing ratesMuni Bond MarketsPrimary market dealings involve a public offering underwritten by investment bankers and can be sold through either competitive bidding (general obligation bonds) or direct negotiationsSecondary market dealings are bought and sold on an over-the-counter market consisting of nearly 2,700 securities dealers (banks and brokerage firms) who are registered with the Municipal Securities Rulemaking Board (MSRB)VolumeApproximately $2.3 Trillion worth of municipal bonds and about 2 Million separate bonds outstanding Decline in issuance with economic downturn of 2007/2008Daily trades average about $11 BillionInsured Bonds In TroubleMany AAA-rated munis are backed by monoline insurers, or insurers who specialize in one type of securityWith the real-estate collapse, monoline insurers lost much of their capital due to investments in Collateralized Debt Obligations (CDOs)Ambac Financial Chart M.B.I.A. Financial ChartInsured Bonds in Trouble Cont’dThese losses have bond rating companies such as Moody’s and Standard and


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