# Municipal bond

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## Disclosures to investors

Key information about new issues of municipal bonds (including, among other things, the security pledged for repayment of the bonds, the terms of payment of interest and principal of the bonds, the tax-exempt status of the bonds, and material financial and operating information about the issuer of the bonds) typically is found in the issuer's official statement. Official statements generally are available at no charge from the Electronic Municipal Market Access system (EMMA) at http://emma.msrb.org operated by the Municipal Securities Rulemaking Board (MSRB). For most municipal bonds issued in recent years, the issuer is also obligated to provide continuing disclosure to the marketplace, including annual financial information and notices of the occurrence of certain material events (including notices of defaults, rating downgrades, events of taxability, etc.). Continuing disclosures also are available for free from the EMMA continuing disclosure service.

## Comparison to corporate bonds

Because municipal bonds are most often tax-exempt, comparing the coupon rates of municipal bonds to corporate or other taxable bonds can be misleading. Taxes reduce the net income on taxable bonds, meaning that a tax-exempt municipal bond has a higher after-tax yield than a corporate bond with the same coupon rate.

This relationship can be represented mathematically, as follows:

$r_m = r_c ( 1 - t ) \,$

where

• rm = interest rate of municipal bond
• rc = interest rate of comparable corporate bond
• t = tax rate

For example if rc = 10% and t = 38%, then

$r_m = (10%)(100% - 38%) = 6.2% \,$

A municipal bond that pays 6.2% therefore generates equal interest income after taxes as a corporate bond that pays 10% (assuming all else is equal).

The marginal tax rate t at which an investor is indifferent between holding a corporate bond yielding rc and a municipal bond yielding rm is:

$t = 1- \frac{r_m}{r_c}.$

All investors facing a marginal rate greater than t are better off investing in the municipal bond than in the corporate bond.

Alternatively, one can calculate the taxable equivalent yield of a municipal bond and compare it to the yield of a corporate bond as follows:

$r_c = \frac{r_m}{( 1 - t )}$

Because longer maturity municipal bonds tend to offer significantly higher after-tax yields than corporate bonds with the same credit rating and maturity, investors in higher tax brackets may be motivated to arbitrage municipal bonds against corporate bonds using a strategy called municipal bond arbitrage.

Some municipal bonds are insured by monoline insurers that take on the credit risk of these bonds for a small fee.

## Subprime mortgage crisis

The municipal bond market was affected by the subprime mortgage crisis. During the crisis, monoline insurers that insured municipal bonds incurred heavy losses on the collateralized debt obligations (CDOs) and other structured financial products that they also insured. Consequently, the credit ratings of these monoline insurers were called into question, and the prices of municipal bonds fell.

## Default rates

The historical default rate for municipal bonds is lower than that of corporate bonds. The Municipal Bond Fairness Act (HR 6308),[11] introduced September 9, 2008, included the following table giving bond default rates up to 2007 for municipal versus corporate bonds by rating and rating agency.

## Build America Bonds

Main article: Build America Bonds

Build America Bonds are a taxable municipal bond created under the American Recovery and Reinvestment Act of 2009 that carry special tax credits and federal subsidies for either the bond holder or the bond issuer. Many issuers have taken advantage of the Build America Bond provision to secure financing at a lower cost than issuing traditional tax-exempt bonds. The Build America Bond provision is open to governmental agencies issuing capital expenditure bonds before January 1, 2011.[12][13][14]

## Statutory history

The U.S. Supreme Court held in 1895 that the federal government had no power under the U.S. Constitution to tax interest on municipal bonds.[15] But, in 1988, the Supreme Court stated the Congress could tax interest income on municipal bonds if it so desired on the basis that tax exemption of municipal bonds is not protected by the Constitution.[16] In this case, the Supreme Court stated that the contrary decision of the Court 1895 in the case of Pollock v. Farmers' Loan & Trust Co. had been "effectively overruled by subsequent case law."

The Revenue Act of 1913 first codified exemption of interest on municipal bonds from federal income tax.[17]

The Tax Reform Act of 1986 greatly reduced private activities that may be financed with tax-exempt bond proceeds.[18]

IRC 103(a) is the statutory provision that excludes interest on municipal bonds from federal income tax.[19] As of 2004, other rules, however, such as those pertaining to private activity bonds, are found in sections 141–150, 1394, 1400, 7871.

## References

1. ^ Missing or empty |title= (help)
2. ^ O'Hara, Neil (2012). The Fundamentals of Municipal Bonds. Hoboken, NJ: John Wiley & Sons, Inc. p. 2. ISBN 978-1-118-16682-6.
3. ^ Fahim, Mayraj. "Local Government Advisor". Retrieved 13 November 2012.
4. ^ Ripley, William (1915). Railroads: Finance & Organization. New York: Longmans, Green, & Co. pp. 106–107. ISBN 1-58798-074-6.
5. ^ O'Hara, Neil (2012). The Fundamentals of Municipal Bonds. Hoboken, NJ: John Wiley & Sons, Inc. p. 55. ISBN 978-1-118-16682-6.
6. ^ Joffee, Marc. "The Safety of State Bonds". Retrieved 13 November 2012.
7. ^ Temal, Judy Wesalo (2001). The Fundamentals of Municipal Bonds: The Bond Market Association. John Wiley and Sons, Inc. p. 49. ISBN 0-471-39365-7.
8. ^ a b "Types of Tax Free Bonds". SIFMA. Retrieved 13 November 2012.
9. ^ Tax regulations
10. ^ http://www.marksmarketanalysis.com/2010/09/harrisburg-to-weigh-hiring-bankruptcy.html
11. ^ http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_reports&docid=f:hr835.110
12. ^ DerivActiv MuniMarket Pulse. "Mier of Loop Capital Says an Issuer 'Can Get Access to All These New Buyers by Going Taxable'" Retrieved on May 23, 2009
13. ^ Internal Revenue Service. "IRS Issues Guidance on New Build America Bonds" Retrieved on May 23, 2009.
14. ^ Rosenberg, Stan. "Louisiana Joins Build America Bond Parade With \$121 Million" Wall Street Journal. May 27, 2009. Retrieved on May 31, 2009.
15. ^ Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429, 15 S. Ct. 673, 39 L. Ed. 759 (1895)
16. ^ South Carolina v. Baker, 485 U.S. 505, 108 S. Ct. 1355, 99 L. Ed. 2d 592 (1988)
17. ^ Revenue Act of 1913
18. ^ Tax Reform Act of 1986
19. ^ IRC 103(a).