US Bonds

Fixed Income Summary

This blog post summarizes the key concepts covered in the Fixed Income course, focusing on municipal and corporate bonds.

Municipal Bonds

Introduction to Municipal Bonds

Municipal bonds are debt securities issued by state and local governments to finance public projects such as roads, schools, and hospitals. They are attractive to investors seeking tax-advantaged income.

Types of Municipal Bonds

General Obligation Bonds (GOs)

• Backed by the full faith and credit of the issuing municipality, meaning they are repaid from the issuer's general tax revenues.
• Considered less risky than revenue bonds because they are not tied to the performance of a specific project.

Revenue Bonds

• Issued to finance specific revenue-generating projects, such as toll roads, airports, and water systems.
• Repaid from the revenues generated by the project, not from general tax revenues.
• Typically riskier than GOs because their repayment depends on the project's success.

Key Considerations for Municipal Bond Investors

Tax Implications

• Interest income from municipal bonds is generally exempt from federal income tax.
• In-state purchases of municipal bonds are often exempt from state and local taxes as well.

Credit Risk

• Municipal bonds are subject to credit risk, which is the risk that the issuer may default on its debt payments.
• Credit rating agencies such as Moody's and Standard & Poor's (S&P) assess the creditworthiness of municipal bond issuers.

Interest Rate Risk

• Municipal bond prices are affected by changes in interest rates.
• When interest rates rise, bond prices generally fall, and vice versa.

Corporate Bonds

Introduction to Corporate Bonds

Corporate bonds are debt securities issued by corporations to raise capital. They typically offer higher yields than government bonds but also carry higher credit risk.

Types of Corporate Bonds

Secured Bonds

• Backed by specific assets of the issuing corporation, which serve as collateral for the bondholders in case of default.
• Considered less risky than unsecured bonds because bondholders have a claim on the collateral.

Unsecured Bonds (Debentures)

• Not backed by specific assets and are only backed by the issuer's general creditworthiness.
• Riskier than secured bonds because bondholders have no claim on specific assets if the issuer defaults.

Key Considerations for Corporate Bond Investors

Credit Risk

• Corporate bonds are subject to credit risk, the risk that the issuer may be unable to make timely interest payments or repay the principal at maturity.
• Factors influencing credit risk include the issuer's financial health, industry conditions, and overall economic environment.

Interest Rate Risk

• Corporate bond prices move inversely with interest rates.
• When prevailing interest rates increase, the market value of existing bonds tends to decline, and vice versa.

Liquidity Risk

• Corporate bonds, particularly those issued by smaller companies or with unique features, may have lower trading volumes compared to more established or widely held bonds.
• This potential illiquidity can make it more challenging or costly to sell the bonds before their maturity date.

Comparing Municipal and Corporate Bonds

Tax Treatment

• Municipal bond interest is generally tax-free at the federal level, making them attractive to investors in higher tax brackets.
• Corporate bond interest is taxable as ordinary income.

Credit Risk

• Municipal bonds generally have lower credit risk than corporate bonds because governments have taxing authority to generate revenue.

Yield

• Corporate bonds generally offer higher yields than municipal bonds with similar maturities and credit quality to compensate for their higher credit risk.

Key Takeaways

• Municipal bonds are a viable investment option for individuals seeking tax-advantaged income, particularly those in higher tax brackets.
• Corporate bonds typically provide higher yields than comparable government or municipal bonds, but they also come with a greater degree of risk.
• Before making investment decisions, thoroughly evaluate your financial goals, risk tolerance, and the specific characteristics of the bond issue.
• Diversifying bond holdings across different issuers, industries, credit qualities, and maturities can mitigate portfolio risk.
• Staying informed about interest rate movements, economic conditions, and the financial health of bond issuers is essential for making informed investment decisions.