Learning outcomes.

After watching this video, you will be able to

describe
the features of the municipal bonds. You will also be able to
differentiate
between general obligation bonds and revenue bonds. A municipal
bond is a bond issued
by a sovereign local government or a particular territory of a
particular
nation or other government agencies. The term is commonly used
in the United States, which is the largest market for
municipal bonds and the estimated size of the municipal bond
market is more than $4 trillion in the US. Now potential issuers
of municipal
bonds include states, cities, counties, school districts,
public utility districts, publicly owned airports,
sea ports and so on. It could also be any other entity or a group
of at the local or state level. Municipal bonds can be either
general obligation of the issuer or can be secured by specified
revenues. So essentially, you have two basic
types of municipal bonds called as the general obligation bonds.
And basically, revenue bonds. General obligation bonds
have principal and interest that are secured by the full
fate, and credit of the issuer, and they're usually supported by
either the issuer's taxing power. It could be limited or
unlimited taxing power and that's what supports the municipal
bonds. Now in many cases, general obligation
bonds are [INAUDIBLE] approved. The second category is revenue
bonds. In revenue bonds, principle and interest are secured by
revenues
derived from tolls, charges or rent from specialties that have
been built
with the proceeds of the bonds issues. So when you issue a bond,
you basically get some bond proceeds and you deploy them in
projects and the
revenue that is gotten from these projects are essentially used
for
servicing the revenue bonds. Now public projects financed by
revenue bonds can include toll roads, bridges, airports, water
and
sewage treatment facilities. It could include hospitals or
even subsidized housing. Now, many of these bonds issued by
special authorities created for that particular purpose. Now,
most municipal bonds and
notes are typically issued in denominations of $5,000 or
multiples of $5,000. Now as I said, municipal bonds
are issued by states, cities, counties to raise funds. And in
some sense, they basically exercise the issuers borrowing power.
Municipal bonds and municipal bond
holders can basically be bond holders. Municipal bond holders can
purchase
bonds either directly from the issuer at the time of issuance,
i.e.,

in the primary market or from other bond holders at another point

in time after
issuance that is in the secondary market. Now in exchange for
upfront investment
capital like all bonds, the municipal bond holder receives
payments over a period
of time, which is composed of interest. And eventually,
you basically get back the principal. Now, municipal bonds are
more
often than not tax exempt. So, comparing the coupon rates of
municipal bonds to corporate bonds or other taxable bonds can
be a bit misleading. Now, because taxes reduce
the net income on taxable bonds, meaning that a tax exempt
municipal
bond has a higher return or a higher after tax yield than a
corporate
bond with the same coupon trade. So in general, because of the
tax
exempt feature of municipal bonds, the interest rates typically
tend to be
several percentage points or several basis points below the going
rate on corporate
bonds of comparable quality and trading. So in other words, a
municipal bond
will often provide the same after tax yield to an investor as a
corporate
bond tries to yield several points more or several percentage
points more or
several basis points more on the coupon. Now many of the
countries in the world
apart from the US also issue municipal bonds, they're sometimes
called local
authority bonds or have other names. The key defining feature of
this type of
bond is that they are issued by a public entity at a lower level
of governance
than the federal government or the sovereign government. As a
result, it's possible that
the municipality can default, even when the country or
the federal government may not default. So it's important to
remember that
we know the current quality or the chance of a default of
a municipal bond issuer is a lot higher than that of the
sovereign,
or the government bond. Because at the end of the day, the
government has the ability to print money, which obviously, a
state or a government
entity lower than that certainly does not. So essentially, two
key things that you
may want to take away and remember. One, municipal bonds
have tax exempt features. So therefore,
the coupon rates tend to be lower than that of corporate bonds

of similar risk rating. Secondly, even though they are,

these are government entities. There is a possibility of a
default, i.e., your interest payment,
your principal may never come back. However and for the
compensation for
the increased risk, you basically get a higher
return than government bonds. So, tax exempt feature. And
secondly, the greater risk of
default as compared to government bonds.