Municipal bonds: concept, types, yield, advantages and disadvantages

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

Government bodies are implementing economic policy aimed at improving the standard of living of citizens. Covering the deficit of finance intended for the implementation of state programs is carried out by attracting loans. One of the ways to fill local budgets is the sale of municipal bonds.

Concept

These are securities issued by local self-government bodies. They are debt obligations, which indicate the repayment period of the loan, guaranteeing their holders to receive a certain remuneration - discount or coupon income. The issuers in this case are states, provinces, city governments, state-owned toll roads.

Investors have the opportunity to purchase such securities during their placement on the stock market, as well as buy them on the secondary market from holders.

AdditionalThe attractiveness of municipal bonds is that the coupon income on them is exempt from local and state taxation.

You can buy bonds of this type on the Russian stock market, and by their status they are equal to government bonds. The fulfillment of obligations under such securities is ensured by collecting local taxes, income from investment projects, houses, bridges, roads.

Municipal bonds differ from state bonds in the level of collateral and issue subject. The provision of such securities is not guaranteed by the government of the countries, unless such a condition is separately stipulated. That is why they are considered a more risky investment, where the return of the debt is guaranteed by the reputation of the municipality or collateral.

Features

Municipal bonds are a profitable investment direction for those wishing to purchase securities. They prescribe specific terms for repayment of the debt, the income rate is indicated in advance. The decision on emission is made by local governments.

Views

Securities, depending on whether there is a pledge or not, are divided into unsecured and secured.

Let's take a closer look at the types of municipal bonds.

Specialists classify them as follows:

1. With a premium and sold at face value.
2. Interest-free, interest-bearing.
3. Coupon free, coupon.
4. Special, targeted.

Loans are classified bythe following features:

1. Market, non-market.
2. External, internal.
3. By expiration date.

Also, municipal bonds can have different purposes:

1. Development of regional infrastructure.
2. Stabilization of the project (protecting the estimate from a shortage of funds).
3. Eliminating the budget deficit.

Examples

Sub-federal (municipal) bonds are most common in the US. Approximately half of government securities are municipal-type securities. The peak of this market was in 2010, when the value of all issued securities was about 3.8 trillion dollars, which, in turn, exceeded half of the country's GDP.

Municipal bonds first appeared in the US in the 19th century. By raising funds, it was possible to build the Erie Canal in New York, as well as the New Orleans Port. After the end of the civil war, the construction of railway lines throughout the continent began. These works were paid for at the expense of funds that were raised by issuing bonds.

The development of the municipal bond market in Russia began in 1992, and by the beginning of the 2000s, about 100 issues of securities had been made. After that, the indicators stabilized around this figure.

Some Russian entities are still actively using bonds to raise loans for development. Among the leading regions in the market of municipal organizations is St. Petersburg,Tomsk region, Moscow.

For example, for 2018, bonds issued by the Tomsk region are estimated at about 10 billion rubles.

Reliability

Municipal bonds are highly reliable. Since 2003, only one issue of such securities has defaulted. The government makes sure that payments are stable, trying to help problem borrowers. Only government bonds are more reliable than municipal bonds. Due to the high stability of municipal bonds, the yield on them is lower than that of corporate bonds, but higher than on bank deposits. In addition, banks often lose their licenses, and all funds exceeding 1.4 million rubles may be lost. There is no such risk with municipal bonds.

Liquidity

The liquidity of securities of this type is of no small importance. They are always traded on the stock exchange, and the holder can sell or buy them at any time.

The sale entails the receipt of the accumulated coupon income. For example, if 100 rubles are paid once every six months, then a sale after 3 months will allow you to receive 500 rubles of income accumulated over 3 months. Selling a bond can be problematic if there is no demand for it at the time. In this case, the sale will have to be carried out at a discount, or remain the holder of the security until maturity.

In addition, there is a possibility of changes in interest rates ineconomy, respectively, and the cost of all debt securities will change. If rates rise, then municipal bonds become less attractive. This is due to the fact that you can put money on a bank deposit, where the percentage of income will be higher. This state of affairs leads to a decrease in the value of bonds. This is important to consider if the owner of the bonds does not plan to hold them until maturity.

Sold and bought municipal bonds of the Russian Federation on the exchange, to which individuals do not have access. This will require a broker - an intermediary who trades.

Disadvantages and advantages

Thus, we can highlight the advantages and disadvantages of such papers. Among the advantages, there is a high level of reliability, as well as the yield of municipal bonds, the absence of tax on coupon income, liquidity, and a low level of risk of losing funds. Among the disadvantages are the need to pay a tax on the difference (if the sale is carried out at a price exceeding the purchase price), the impossibility of independently buying and selling on the exchange (this will require the services of a broker), as well as the need to reduce the price if you want to sell bonds and there is no demand for them.

Evaluating all the advantages and disadvantages of municipal bonds, we can conclude that these securities are a good investment tool, especially if the contribution is made for a short period.