Chapter One
Types of Municipal Securities
Businesses and governments both need to finance their activities. Businesses can raise money by selling ownership (stocks) or by issuing debt (bonds). Unlike businesses, governments cannot sell ownership in themselves to raise money. So governments are restricted to issuing bonds. Bonds are like IOUs: promises to repay borrowed funds by a certain date and, usually, to pay period interest as well. There are other types of municipal securities, but regardless of their fancy names and features almost all of them work like bonds, in the sense that the investor is a lender entitled to a (mostly) predictable return.
The maturity of a bond is when the amount of money originally borrowed, called the principal, must be repaid. Most bonds mature between one and twenty years from the date they were issued. The principal that is printed on a bond certificate is called its par value, also known as its face value. This is 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, called coupon payments, and it must be paid religiously as long as the borrowing entity is solvent. Note that the final coupon payment is typically due on the bond’s maturity date and will be paid along with the principal.
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, and any peculiar features the bond may have. Normally, longer term bonds carry higher coupon rates than shorter term bonds. Issuers wit