Types of Municipal Bonds
Municipal governments cannot sell ownership interest (equity securities), so in order to raise money, municipalities issue bonds.
Bonds have a maturity date ranging from 1 to 20 years or more. The maturity is the date the bond must be redeemed, that is, when the amount of money originally borrowed, the principal, must be repaid. The principal that is printed on a bond certificate is called its par value, also called the face value. This is typically the amount the investor lends to the borrower when he buys the bond, and this is what the investor will get in return at the bond’s maturity.
The interest rate, also called the coupon rate or nominal yield, is the percentage of the principal written on the bond certificate that must be paid annually as payment for the loan. For example, a coupon rate of 5% on a $1,000 bond requires the issuer to pay the bondholder $50 interest annually. Interest is usually paid in two semiannual installments, and it must be paid religiously as long as the borrowing entity is solvent. The coupon rate is a function of many factors, including:
- • The issuer’s credit standing at time of issue
- • The term of the bond
- • Prevailing interest rates
- • Any peculiar features the bond may have
Normally, longer term bonds carry higher coupon rates than shorter term bonds. Also, issuers with higher credit ratings will issue bonds with lower coupon rates.
Market interest rates are constantly changing and may change dramatically during the life of a bond, but the nominal yield of a bond will always reflect the interest rate stated on the bond certificate.
Suppose you want to sell your 6% bond in the market, but because interest rates have risen since you purchased your bond, bonds that are similar to yours are now being issued at 8%. No one will pay $1,000 to get $60 per year when they can buy another bond of the same amount and get $80. Your bond will no