What is a Municipal Bond

A Municipal Bond (or muni) is a bond issued by a city or local government in the United States. Some of the bodies that can issue Municipal Bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports and any other governmental entity below the state level.

Guarantee for Municipal Bonds is provided by the local government, a subdivision of the local government, or a group of local governments. All Municipal Bonds are pre-assessed for risk and are given an appropriate rating.

In most cases, the income generated by a Municipal Bond holder by the interest on the bonds is exempt from both the Federal Income Tax and the State Income Tax (for the state in which the bonds were issued). There can be exceptions to this and certain bonds could be declared taxable.

Whether the income received by bondholders through the interest on the bonds is taxable depends largely on the type of projects that are funded by that bond. For instance, if the bonds were issued to gather money for a construction that is meant for the welfare of the public, those bonds are not likely to be taxed. On the other hand, if the bonds are used for a project that would only benefit a handful of private parties, then the federal or state taxes might be applicable.

The laws for determining which bonds are to be taxed and which are not are very complicated. The taxable status of every bond is fixed before it reaches the market. If you are a regular buyer of Municipal Bonds then you should know that not all of them are tax-exempt.

The risk (or security) associated with a Municipal Bond is determined on the basis of the ability of the issuing body to make all payments on time and in full, as pledged in the agreement between the issuer and the bond holder. Different bonds have different types of securities based on the commitments that are formally documented in the bonds.

Some of these are:

* General Obligation Bonds - These assure that the bond value will be repaid on full faith and credit of the issuer. These bonds are supposed to be the most secure Municipal Bonds and carry the lowest interest rates.

* Revenue Bonds -These assure that the bond value will be repaid from a stream of future income once the project is complete. Toll payments are frequently used to pay for such projects. These Municipal Bonds are slightly risky because they rely on the success and profitability of the project. They do carry a slightly higher interest rate.

* Assessment Bonds - These assure that the bond value will be repaid based on the property tax assessments of the properties located within the issuer's boundaries.

There are rating agencies used for the purpose of determining the probability of repayment as is assured by the bond issuer before the bonds are issued.

Standard & Poor's, Moody's, and Fitch are the three top rating agencies for Municipal Bonds in the United States. Any bond issuer can sign up with these agencies to get a bond rating.

Bond buyers must pay close attention to the rating before purchasing any bonds.

Check out http://www.bond-trading.org/ for articles on eurobond and municipal bonds.

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Is There A Bubble In The Bond Market?

Conditions in the bond market don't match the textbook definition of a bubble, but aggressive bond investors are positioning themselves to lose stunning amounts of money.

Interest rates are currently near all-time lows, and there's a heated debate as to why. Optimists will tell you that rates are low because global governments and central banks are stimulating the world economy. Pessimists will tell you that rates are low because we are on the verge of something terrible. A recession, a depression - call it what you will, but it will be so bad that prescient investors are content to lock in today's rates for the long term.

Of course, we know that the optimists are on the right track, at least to some degree. Government intervention has created distortions in the bond market. The Federal Reserve has set the target federal funds rate between 0 percent and 0.25 percent, and is buying up U.S. Treasury bonds. By doing this, it has caused interest rates to drop across the board. From mortgage rates to bond yields to the interest rate on your bank account, rates continue to decline.

As for the pessimists? It is impossible to say at this point whether they will be vindicated, but it's clear that investors share their concerns. The last decade has scared many investors away from stocks and sent them looking for safer investments. The numbers are mind-boggling. More money flowed into U.S. bond mutual funds in 2009 than in the previous 10 years combined. As of June 2010, more money flowed into bond funds than into stock funds for 30 months in a row. So it's not just the heavy hand of the government that is pushing down interest rates; retail investors are playing a role too, by selling stocks and dumping all their cash into bonds (and thus bidding up bond prices).

So everyone is buying bonds, and no one seems to be particularly concerned with the price. Sounds like a bubble, doesn't it?

Why The Bond Market Is Not In A Bubble

The history of bubbles in the investment world dates back hundreds of years. Unfortunately, people seem to be hard-wired, and it is very difficult for us to resist investments that are on the way up. From Dutch tulips in the 1600s to tech stocks in the 1990s to the recent real estate bubble, investors keep getting snookered looking for the next big thing. These bubbles always follow the same path: Prices rise until they reach unsustainable levels, with no underlying logic or connection to fundamental valuation principles. Investors take on debt to buy more and more of the bubble investment. And all kinds of shady characters come out of the woodwork to perpetrate frauds and take advantage of the situation. In the end, the bubble pops. Investors lose massive sums of money and the fraudsters are punished.

The reason the bond market is not in a bubble is that investors can hold their bonds to maturity. Assuming their bonds don't default, investors will recover 100 percent of their principal. In addition, we are not seeing speculative activities as we have seen in other bubbles. (Is anyone taking out a second mortgage to buy Treasury bonds?) Lastly, there's no indication of fraud in the run-up in bond prices - the largest seller of bonds to Americans is the U.S. government.

In a way, this is all semantics. The situation won't be a repeat of the tech stock or real estate bubbles. But there is a lot of money at risk, and reckless investors may end up damaging their financial futures.

Potential Losses For Bond Investors

The most important concept that bond investors need to be familiar with is interest rate risk. As interest rates increase, bond prices decrease. And the longer a bond's maturity period, the more dramatically the price will drop in the event of interest rate increases.

Here is an example of how interest rate risk works. Suppose there are two bonds, both selling at par (100 cents on the dollar). The first bond matures in one year with a yield of 1 percent, and the second bond matures in 30 years with a yield of 3.5 percent. Long-term bonds typically offer higher yields because the investor has to wait longer to recover her principal. If interest rates go up 1 percentage point, both bonds will immediately lose some of their value. The one-year bond will lose about 1 percent of its value. In response to this paper loss, the investor may decide to continue holding the bond until it matures at the end of the year. She will receive her principal back, plus the 1 percent yield.

However, the 30-year bond will lose more value because of its longer maturity. Instead of 1 percent, the bond would lose about 16 percent of its value. The investor can continue to hold the bond until it matures in 30 years, but that will be a long wait. In the meantime, she has a bond worth 84 cents for every dollar she paid, and if she needs to sell her bond to pay for current expenses, she'll have no choice but to realize the loss.

The higher we assume that interest rates go in the next few years, the more staggering the potential losses become. Let's take the same two bonds that we used in our last example, and assume that interest rates go up 5 percentage points. The one-year bond will lose approximately 5 percent of its value. Again, all the investor needs to do is to wait a year, and she will receive her principal plus the 1 percent yield. The 30-year bond loses about 54 percent of its value. And bonds are supposed to be a safe investment!

The most likely scenario in which interest rates will rise is an increase in economic activity, which will lead to a healthy increase in inflation. With inflation currently near all-time lows and investors becoming more and more concerned about deflation, an increase in interest rates could be a very good sign for the global economy. Only bond investors would be hurt in this scenario, while business owners, consumers and stock investors would all be better off.

A Smart Approach To Bond Investing

I hope the previous examples have made clear the danger of purchasing long-term bonds. If you are convinced that we are headed for financial Armageddon, then locking in today's long-term rates is an attractive proposition. But buying today's long-term bonds is a bet that the economy will not recover for the next 10, 20, even 30 years. It is a bet that there will be no inflation in consumer products, medical costs or education. It is a bet that wages will not increase, and neither will rents or real estate values. This is not a bet we are interested in making for our clients.

At Palisades Hudson, we currently focus on short-term, high-quality bonds for our clients' fixed-income allocations. We also invest in bonds such as Treasury Inflation-Protected Securities (TIPS) that, unlike typical fixed-income securities, will appreciate in value as interest rates and inflation increase. While our positioning might sacrifice some yield in the short term, our main objective when investing in fixed-income vehicles is to reduce volatility. We believe that our current fixed-income portfolios accomplish that goal.

In the past, bonds have been viewed as a safe investment. Unfortunately, prices have been bid up on long-term bonds to the point where this is no longer the case. Rates will eventually rise: Make sure that your investments won't suffer when they do.

For more articles, please visit the Palisades Hudson Financial Group LLC newsletter or subscribe to the blog.

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How to Invest in Bonds

E*Trade claims finding and buying stocks is so easy, it can be done by a baby, so you already know how to do it, correct?

While stock brokers over the previous 10 years online have tried to make investing in stocks as easy as child's play, unfortunately, investing in bonds has been slower to evolve. On many broker sites online, bond platforms are not even in existence. Therefore, the world of investing in individual bonds remains murky.

While a certain percentage in your personal portfolio should be invested in bonds - a rule of thumb is 40% for someone in their 40s - you may have relied on mutual funds bonds for that portion. That in itself may not be bad since mutual bonds funds allow you to own bonds from several hundred companies while investing just a small amount. Also, professional managers do the bond investment research for you. Bond funds, however, also have a disadvantage to owning those individual bonds, which is significant.

When you purchase a bond, you know the following:

* the exact amount of your interest payments

* when your payments will be received

* when your initial investment will be paid back - so long as there is no default of the company.

On the other hand, prices of the bond funds move up and down the same as other mutual funds. If your money is needed by you on any specific date, you do not know what value to expect of your mutual fund on that date. This makes individual bond investing, therefore, preferable for those who may need a certain amount of money at a particular time.

As an example, say you would need tuition in the amount of $40,000 for your 16-year-old to attend college at age 18. You would need to invest $40,000 in two-year individual bonds, and in investing that way, you would be assured of having that amount of money when you need it - so long as the company stays solvent and no bankruptcy occurs. If it is otherwise invested in bond mutual funds, no-one would know what it would be worth when it is time to withdraw the funds. Typically, bonds do not go down by any large percentage, but in the year 2008 we learned that is not always true.

If you need a certain retirement income stream, or are saving for a timely goal, and you think you may profit by investing in individual bonds, here is a primer on the way bonds work:

How bonds work

Treasury bonds are issued by the United States Treasury Department to finance the Federal Government's operations. In a similar way, states, cities, corporations and companies issue bonds as a means of financing their operations. Considered a safe investment, Treasury bonds normally have no default risk. When a corporation or company issues bonds to raise money, however, investors demand interest rates that are higher than U.S. Treasury bonds offer, as compensation for the risk to investors in the event the corporation or company goes into bankruptcy.

For example, if a company - say General Electric - needed to raise an amount of one hundred million dollars for the building of a new factory to manufacture refrigerators, and planned to pay back the loan in 2020, they would look at the market in order to determine the interest rate the company would have to offer to interest investors in lending them that amount of money. If the investors' demand was 6%, General Electric would then issue one hundred million in bonds with an interest rate - the coupon rate - of 6%, for immediate purchase, by pre-agreement with mutual funds, banks and possibly, individuals. Company bonds are mostly available in $1,000 denominations - called par value.

For each $1,000 bond the investor owned, therefore, he or she would receive $60 back - 6% of $1,000 - per year for each year until 2020, when he or she would get the entire $1,000 back.

Between the time that General Electric issued the bond and the time that the bond would mature - or come due - the investors are able to sell the bonds in the secondary market. Just like stock prices, however, bond prices will fluctuate.

If General Electric had issued the bond three years ago, the company's chances since then of surviving until 2020 may still be good, but may be definitely gloomier. If so, an investor selling his bond today will need to offer the buyer a higher interest rate than the 6% he originally paid for it, due to the extra risk to the buyer. General Electric, however, will still pay $60 per year to the new investor. Therefore, the new investor will expect to buy the bond at less than the par value.

While the coupon rate of the bond will remain at 6%, if the new investor pays $900 for the bond, that makes the yield higher because he has only invested $900 for a $60 yearly return, and because he will still get back $1000. for the bond at maturity.

Of course, the reverse can happen, and at times investors buy bonds for more than par value, and that reduces the yield.

The trouble with buying bonds

Small investors, unfortunately, have more difficulty buying individual bonds than they would in buying individual stocks. One reason is, there are more single bonds than single stocks. Think of this: One single company may have several different times when it wanted to borrow capital, meaning it would have several different bonds offered on the market, as opposed to only one common stock.

More importantly, the process of actually buying a bond is not easy. Most often, the stock broker acts as an intermediary between the buyer and the seller. Bond brokers, however, often are the investors who actually buy or sell you the bond. As an individual bond investor, therefore, unless you have more than one broker, your bond purchases will be limited to whatever bonds your broker has in his inventory at any given time.

Another area of confusion is bond commissions. Whereupon you may pay a flat commission in buying and selling stocks, with bonds the commission is built right into the price of the bond. For instance, if your broker originally paid $1000 for a bond that yielded 7%, he may offer it to you for $1100, and that means you would realize a yield of only 6.4%. That is, $70 divided by $1100. The difference between the price he paid and the price at which he sells it to you, becomes his commission. Larger investors who are able to invest millions of dollars into bonds at one time tend to get better price offers than small investors, who may be able to invest only $10,000 in bonds at a time.

Until recently, smaller investors were unable to see how much other investors bought and sold bonds for, meaning that the broker had the potential to seriously scam the small investor. SIFMA, fortunately, has now built a website where individuals can research prices of recent bonds transactions.

Why the hassle is worth it

With all this information, one may wonder: Why bother?

For small start-up investors, or those who have only a small portion of their portfolios set aside for bonds - less than $100,000 - the short answer is - Don't! Stick with a low expense no-load mutual fund - like this one or that one - until you have more funds accumulated to invest in bonds.

For investors who meet the criteria, though, using bonds will create the kind of predictable income stream that no bond fund is able to guarantee.

James Fowlkes is the creator of the SimpleVesting Investing Course - Investing Made Simple. SimpleVesting Is Designed To Guide You Through Changing Markets. A Safer Way To Reach Your Retirement Goals. Discover more here--> http://www.jamesfowlkes.com

Security Bonds 101, What Security Bond is Right For You?

Security in the language of business economics is the written (or electronic) evidence of ownership that provides the right to receive property or some other benefit that is currently not in direct possession of the holder. That is a pretty boring way of saying it is a piece of paper that says you own a chunk of a company or at least a chunk of its profits.

The most common forms of security are Stocks and Bonds, the buying and selling of these forms of security are the bread and butter of the stock market exchange. Both stocks and bonds are a type of corporate security. Bonds represent a debt of the corporation while stocks represent ownership or equity interest in the operations of a company.

Bonds Come In All Flavors and Sizes

A bond is a tool used by companies to raise money to invest in their business. The bond signifies the promise of the corporation to pay back the price of the bond with interest paid throughout the life of the bond at preset periods of time.

Bonds are good for investment because they tend to provide a safer return on the investment but still provide relatively high dividends.

Bonds are very flexible which is why they are such an attractive type of investment. They can be registered to a certain person, a group of people or, as it is more common, they are made payable to the bearer. The bondholder, whoever he may be, receives his interest payments by redeeming coupons attached to bond. These characteristics make bonds an excellent form of cash, which gives interest but is generally easily liquidated when needed.

However, companies would struggle if asked to pay all their bonds at once which is why it is common for them to pay them gradually through serial maturity dates or by using a sinking fund that saves a certain percentage of profit in order to pay outstanding bonds. It is smart therefore to make sure what type of policy the company you buy bonds from so there are no surprises when you need to cash in your bonds.

The main type of bond is the Mortgage Bond. This bond represents a claim on a real, specific property. These bonds are of the safer types and ordinarily results in bond owners receiving a priority treatment if financial difficulties occurred. However it seems like the irresponsible selling and dealing in mortgage based investment securities triggered or at least played an important role in the current housing, credit and mortgage crisis. It therefore pays to check what kind of mortgage bonds you buy into.

Another important bond type is the Collateral Trust Bond. The security for collateral trust bonds is an intangible property, often stocks and bonds that the company owns. This type of bond guarantees that if the company can't pay your bond you get a piece of their company. This does not seem to be much help because by then the company is not likely to be worth much.

An interesting type of bond is the Convertible Bond. This hybrid bond adapts to varying circumstances. It can be exchanged for common shares at specified prices that can change over time. This bond is attractive because it can be very effective obtaining funds at a low interest at the beginning of a project when income is low but encourages conversion of bonds (debt) to ownership (stock). It is also a good option for clients that obtain a price protection on their investment without losing the possibility of profit provided by the stock feature. Obviously this is an attractive bond in periods of market uncertainty.

Another type of hybrid bond is the Income Bond. The Income Bond has a fixed maturity but you only get interest paid on it if the company also earns it. Historically these bonds appeared when railroads were "reorganized" which is fancy for gone bankrupt and bought by another corporation. The new owner offered this hybrid type of bond which was good for bond holders because it meant they didn't lose everything and allowed the company to wait until they were making a profit to pay dividends on the bonds.

Linked Bonds are yet another hybrid type of bond where the interest returns are linked to some standard value, like the price of gas, a cost of living index, a foreign currency or a combination of all the above. These bonds were popular in the states during inflationary periods and are not as common today. They are still used in countries where the fear of inflation deters investors from buying fixed income bonds. The idea is that there is little benefit in getting a 10% interest on your investment if the price of bread or the overall cost of living has risen by 30%. Linked bonds are designed to guarantee the return on your investment is real and not just a numbers game.

As you can see there are all kinds of bond securities to invest in. Bonds may be one of the safest and smartest investments for people who don't want the risk of buying and selling stocks but still want the potential for high returns on their investment. The hybrid bonds provide the best balance between security and profit potential. However no portfolio or circumstances are the same so contact a certified agent to find out what product is best for you.

Andrew Latham.

Learn more about Finance, Insurance and Superannuation at.

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Lebenthal On Munis: Straight Talk About Tax-Free Municipal Bonds for the Troubled Investor Deciding "Yes...or No!"

IF YOU KNEW WHAT I KNOW...
Would you buy a municipal bond for the subways in New York City that’s rated AA-, or only A?
Would you care what a bond is for as long, as it’s a general obligation backed by the issuer’s full faith, credit, and taxing power?
Would you pay 109 for a bond, a premium of $90 for every $1,000 face value, knowing you’re going to get back only $1,000 at the end??Would it be crazy to buy a 30-year bond at age 80?
Would you read “these bonds are not a debt of the state” as a fair warning, Buyer Beware??Tax free municipal bonds.  Would you buy them at all?
STRAIGHT TALK FROM THE MAN WHO PUT MUNIS  ON THE MAP FOR THE INDIVIDUAL INVESTOR.
Would telling you the whole story about investing in municipal bonds, and  making sure you know the risks involved, kill the sale?  “I’ll take my chances,” says Jim (Municipal Bonds Are My Babies) Lebenthal.
 For 45 years, Jim Lebenthal wrote and starred in the Lebenthal family’s municipal bond business commercials -  information nuggets that educated the public and turned munis into a household word, wherever his face and voice were seen and heard.
Outraged by what Wall Street had done to the financial markets with reckless abandon, and Bernie Madoff with malice aforethought, Jim gives equal time in Lebenthal On Munis…Deciding, "Yes…" or "No!" to the Whys and Why Nots for investing in his "babies."
"Balancing the heady appeal of tax exemption with the payment record of municipal bonds in the Depression and the volatility of resale prices during the inflation tortured '70s and '80s, isn’t optional for a broker," says Lebenthal.  "Full Disclosure is the law."
In Lebenthal on Munis, Jim carries out that law, even if Full Disclosure means turning Jim and his babies, thumbs down.
DECIDING, "YES…" OR "NO!"

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