Você está na página 1de 36

Chapter 8

Municipal
Securities

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-1
Learning Objectives
After reading this chapter, you will understand
 the two basic security structures: tax-backed debt and
revenue bonds
 the flow of funds structure for revenue bonds
 municipal bonds with hybrid structures and special bond
security structures such as refunded bonds and insured
municipal bonds
 the different types of tax-exempt short-term municipal
securities
 what municipal derivative securities are

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-2
Learning Objectives (continued)
After reading this chapter, you will understand
 the two basic security structures: tax-backed debt and
revenue bonds
 how municipal inverse floaters are created
 the tax risk that investors face when investing in
municipal securities
 yield spreads within the municipal market
 the shape of the municipal yield curve
 the primary and secondary markets for municipal
securities
 the taxable municipal bond market

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-3
Types and Features of Municipal
Securities

 There are basically two different types of


municipal bond security structures:
i. tax-backed bonds
ii. revenue bonds
 There are also securities that share
characteristics of both tax-backed and
revenue bonds.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-4
Types and Features of Municipal Securities
(continued)

 Tax-Backed Debt
 Tax-backed debt obligations are instruments issued
by states, counties, special districts, cities, towns,
and school districts that are secured by some form
of tax revenue.
 Tax-backed debt includes general obligation debt,
appropriation-backed obligations, and debt
obligations supported by public credit enhancement
programs.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-5
Types and Features of Municipal Securities
(continued)

 Tax-Backed Debt
 The broadest type of tax-backed debt is general
obligation debt.
 An unlimited tax general obligation debt is the
stronger form of general obligation pledge as it is
secured by the issuer’s unlimited taxing power.
 A limited tax general obligation debt is a limited tax
pledge because for such debt there is a statutory limit
on tax rates that the issuer may levy to service the debt.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-6
Types and Features of Municipal Securities
(continued)

 Tax-Backed Debt
 Agencies or authorities of several states have
issued bonds that carry a potential state liability
for making up shortfalls in the issuing entity’s
obligation.
 However, the state’s pledge is not binding.
 Debt obligations with this nonbinding pledge of
tax revenue are called moral obligation bonds.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-7
Types and Features of Municipal Securities
(continued)

 Revenue Bonds
 The second basic type of security structure is found in a
revenue bond.
 Such bonds are issued for either project or enterprise
financings in which the bond issuers pledge to the
bondholders the revenues generated by the operating
projects financed.
 For a revenue bond, the revenue of the enterprise is pledged
to service the debt of the issue.
 The details of how revenue received by the enterprise will
be disbursed are set forth in the trust indenture.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-8
Types and Features of Municipal Securities
(continued)

 Revenue Bonds
 There are various restrictive covenants included in the trust
indenture for a revenue bond to protect the bondholders.
 A rate, or user charge, covenant dictates how charges will be
set on the product or service sold by the enterprise.
 Other covenants specify that
i. the facility may not be sold
ii. the amount of insurance to be maintained
iii.requirements for recordkeeping and for the auditing of the
enterprise’s financial statements by an independent accounting firm
iv. requirements for maintaining the facilities in good order

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-9
Types and Features of Municipal Securities
(continued)
 Revenue Bonds
 Examples of revenue bonds include:
i. Airport Revenue Bonds
ii. Higher Education Bonds
iii. Hospital Revenue Bonds
iv. Single-Family Mortgage Revenue Bonds
v. Multifamily Revenue Bonds
vi. Public Power Revenue Bonds
vii. Resource Recovery Revenue Bonds
viii.Student Loan Revenue Bonds
ix. Toll Road and Gas Tax Revenue Bonds
x. Water Revenue Bonds
xi. Pollution Control Revenue and Industrial Development
Revenue Bonds

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-10
Types and Features of Municipal Securities
(continued)

 Hybrid and Special Bond Securities


 Some municipal bonds that have the basic
characteristics of general obligation bonds and
revenue bonds have more issue-specific
structures as well.
 Some examples are
i. insured bonds
ii. bank-backed municipal bonds
iii. refunded bonds structured/asset-backed securities
iv. “troubled city” bailout bonds

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-11
Types and Features of Municipal Securities
(continued)
 Hybrid and Special Bond Securities
 Insured bonds, in addition to being secured by the issuer’s
revenue, are also backed by insurance policies written by
commercial insurance companies.
 Because municipal bond insurance reduces credit risk for the
investor, the marketability of certain municipal bonds can be
greatly expanded.
 There are two major groups of municipal bond insurers.
i. The first includes the monoline companies that are primarily in the
business of insuring municipal bonds.
ii. The second group of municipal bond insurers includes the multiline
property and casualty companies that usually have a wide base of
business, including insurance for fires, collisions, hurricanes, and
health problems.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-12
Types and Features of Municipal Securities
(continued)
 Hybrid and Special Bond Securities
 Since the 1980s, municipal obligations have been increasingly
supported by various types of credit facilities provided by
commercial banks.
 There are three basic types of bank support: letter of credit,
irrevocable line of credit, and revolving line of credit.
i. A letter-of-credit agreement is the strongest type of support available
from a commercial bank.
 Under this arrangement, the bank is required to advance funds to the
trustee if a default has occurred.
i. An irrevocable line of credit is not a guarantee of the bond issue,
although it does provide a level of security.
ii. A revolving line of credit is a liquidity-type credit facility that
provides a source of liquidity for payment of maturing debt in the
event that no other funds of the issuer are currently available.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-13
Types and Features of Municipal Securities
(continued)
 Hybrid and Special Bond Securities
 Although originally issued as either revenue or general obligation
bonds, municipals are sometimes refunded.
 A refunding usually occurs when the original bonds are escrowed
or collateralized by direct obligations guaranteed by the U.S.
government.
 The escrow fund for a refunded municipal bond can be structured
so that the refunded bonds are to be called at the first possible
call date or a subsequent call date established in the original bond
indenture.
 Such bonds are known as prerefunded municipal bonds.
 Although refunded bonds are usually retired at their first or
subsequent call date, some are structured to match the debt
obligation to the retirement date.
 Such bonds are known as escrowed-to-maturity bonds.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-14
Types and Features of Municipal Securities
(continued)
 Hybrid and Special Bond Securities
 There are three reasons why a municipal issuer may
refund an issue by creating an escrow fund.
i. Many refunded issues were originally issued as revenue
bonds.
ii. Some issues are refunded in order to alter the maturity
schedule of the obligation.
iii. When interest rates have declined after a municipal security
has been issued, there is a tax arbitrage opportunity
available to the issuer by paying existing bondholders a
lower interest rate and using the proceeds to create a
portfolio of U.S. government securities paying a higher
interest rate.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-15
Types and Features of Municipal Securities
(continued)
 Redemption Features
 Municipal bonds are issued with one of two debt
retirement structures, or a combination.
 Either a bond has a serial maturity structure or it has a
term maturity structure.
 A serial maturity structure requires a portion of the debt
obligation to be retired each year.
 A term maturity structure provides for the debt obligation
to be repaid on a final date.
 Municipal bonds may be called prior to the stated
maturity date, either according to a mandatory sinking
fund or at the option of the issuer.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-16
Types and Features of Municipal Securities
(continued)
 Redemption Features
 The municipal market has securities with various features.
 These are zero-coupon bonds, floating-rate bonds, and putable bonds
in the municipal bond market.
 For this market, there are two types of zero-coupon bonds.
i. One type is issued at a very deep discount and matures at par.
o The difference between the par value and the purchase price represents a
predetermined compound yield.
o These zero-coupon bonds are similar to those issued in the taxable bond
market for Treasuries and corporates.
ii. The second type is called a municipal multiplier.
o This is a bond issued at par that has interest payments.
o The interest payments are not distributed to the holder of the bond until
maturity, but the issuer agrees to reinvest the undistributed interest
payments at the bond’s yield to maturity when it was issued.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-17
Municipal Money Market
Products
 Tax-exempt money market products
include:
i. notes
ii. commercial paper
iii.variable-rate demand obligations
iv.a hybrid of the last two products

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-18
Municipal Money Market Products
(continued)
 Municipal notes include tax anticipation notes (TANs), revenue
anticipation notes (RANs), grant anticipation notes (GANs), and
bond anticipation notes (BANs).
 These are temporary borrowings by states, local governments,
and special jurisdictions.
 Usually, notes are issued for a period of 12 months, although it
is not uncommon for notes to be issued for periods as short as
three months and for as long as three years.
 TANs and RANs (also known as TRANs) are issued in
anticipation of the collection of taxes or other expected
revenues.
 These are borrowings to even out irregular flows into the
treasuries of the issuing entity.
 BANs are issued in anticipation of the sale of long-term bonds.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-19
Municipal Money Market Products
(continued)
 Tax-Exempt Commercial Paper
 As with commercial paper issued by corporations, tax-exempt
commercial paper is used by municipalities to raise funds on a
short-term basis ranging from one to 270 days.
 The dealer sets interest rates for various maturity dates and the
investor then selects the desired date.
 Variable-Rate Demand Obligations
 Variable-rate demand obligations (VRDOs) are floating-rate
obligations that have a nominal long-term maturity but have a
coupon rate that is reset either daily or every seven days.
 The investor has an option to put the issue back to the trustee at any
time with seven days’ notice.
 The put price is par plus accrued interest.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-20
Municipal Money Market Products
(continued)
 Commercial Paper / VRDO Hybrid
 The commercial paper/VRDO hybrid is customized
to meet the cash flow needs of an investor.
 As with tax-exempt commercial paper, there is
flexibility in structuring the maturity, because the
remarketing agent establishes interest rates for a
range of maturities.
 Although the instrument may have a long nominal
maturity, there is a put provision, as with a VRDO.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-21
Municipal Derivative Securities (continued)
 In recent years, a number of municipal products have
been created from the basic fixed-rate municipal bond.
 This has been done by splitting up cash flows of newly
issued bonds as well as bonds existing in the secondary
markets.
 These products have been created by dividing the coupon
interest payments and principal payments into two or more
bond classes, or tranches.
 The name derivative securities have been attributed to
these bond classes because they derive their value from
the underlying fixed-rate municipal bond.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-22
Municipal Derivative Securities (continued)
 Floaters / Inverse Floaters
 A common type of derivative security is one in which two classes
of securities, a floating-rate security and an inverse-floating-rate
bond, are created from a fixed-rate bond.
 The coupon rate on the floating-rate security is reset based on the
results of a Dutch auction.
 Inverse floaters can be created in one of three ways:
i. A municipal dealer can buy in the secondary market a fixed-rate
municipal bond and place it in a trust with the trust issuing a floater and
an inverse floater.
ii. As illustrated in Exhibit 8-1 (see Overhead 8-24), the municipal dealer
uses a newly issued municipal bond to create a floater and an inverse
floater.
iii. Using the municipal swaps market, one creates an inverse floater without
the need to create a floater.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-23
Exhibit 8-1
Creation of a Municipal Inverse
Floater
Fixed-rate municipal bond (newly issued or seasoned)

Municipal floating-rate bond Municipal inverse-floating-rate

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-24
Municipal Derivative Securities (continued)
 Strips and Partial Strips
 Municipal strip obligations are created when a municipal
bond’s cash flows are used to back zero-coupon instruments.
 The maturity value of each zero-coupon bond represents a cash
flow on the underlying security.
 Partial strips have also been created from cash bonds, which
are zero-coupon instruments to a particular date, such as a call
date, and then converted into coupon paying instruments.
 These are called convertibles or step-up bonds.
 Other products can be created by allocating the interest payments
and principal of a fixed-coupon-rate municipal bond to more than
two bond classes.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-25
Credit Risk
 Although municipal bonds at one time were considered
second in safety only to U.S. Treasury securities, today there
are new concerns about their credit risks.
i. The first concern came out of the New York City billion-dollar
financial crisis in 1975.
ii. The second reason for concern about municipal securities credit
risk is the proliferation in this market of innovative financing
techniques to secure new bond issues.
 What distinguishes these newer bonds from the more
traditional general obligation and revenue bonds is that there
is no history of court decisions or other case law that firmly
establishes the rights of the bondholders and the obligations
of the issuers.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-26
Credit Risk (continued)
 As with corporate bonds, some institutional investors in the
municipal bond market rely on their own in-house municipal
credit analysts for determining the credit worthiness of a
municipal issue.
 Other investors rely on the nationally recognized rating
companies.
 The two leading rating companies are Moody’s and Standard
& Poor’s, and the assigned rating system is essentially the
same as that used for corporate bonds.
 Although there are numerous security structures for revenue
bonds, the underlying principle in rating is whether the project
being financed will generate sufficient cash flow to satisfy the
obligations due bondholders.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-27
Risks Associated with Investing in
Municipal Securities
 The investor in municipal securities is exposed to the
same risks affecting corporate bonds plus an additional
one that may be labeled tax risk.
 There are two types of tax risk to which tax-exempt
municipal securities buyers are exposed.
i. The first is the risk that the federal income tax rate will be
reduced.
ii. The second type of tax risk is that a municipal bond issued as a
tax-exempt issue may eventually be declared to be taxable by
the Internal Revenue Service.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-28
Yields on Municipal Bonds
 A common yield measure used to compare the yield on a
tax-exempt municipal bond with a comparable taxable
bond is the equivalent taxable yield, which is computed
as:
tax-exempt
equivalent taxable yield 
1  marginal tax rate
 Example: Suppose that an investor in the 40% marginal
tax bracket is considering the acquisition of a tax-exempt
municipal bond that offers a yield of 6.5%. What is the
equivalent taxable yield? 6.5%/(1-40%)
0.065
equivalent taxable yield   0.1083 or 10.83%
1  0.04

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-29
Yields on Municipal Bonds (continued)
 Because of the tax-exempt feature of municipal bonds, the
yield on municipal bonds is less than that on Treasuries with
the same maturity. The yield on municipal bonds is compared
to the yield on Treasury bonds with the same maturity by
computing the following ratio:
yield on municipal bond
yield ratio 
yield on same maturity Treasury bond
 Yield spreads within the municipal bond market are
attributable to differences between credit ratings (quality
spreads), sectors within markets (intramarket spreads),
and differences between maturities (maturity spreads).

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-30
Municipal Bond Market
 Primary Market
 Municipal obligations are brought to market weekly.
 A state or local government can market its new issue by offering
bonds publicly to the investing community or by placing them
privately with a small group of investors.
 When a public offering is selected, the issue usually is underwritten
by investment bankers and/or municipal bond departments of
commercial banks.
 Most states mandate that general obligation issues be marketed
through competitive bidding, but generally this is not required for
revenue bonds.
 An official statement describing the issue and the issuer is prepared
for new offerings.
 Municipal bonds have legal opinions that are summarized in the
official statement.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-31
Municipal Bond Market (continued)
 Secondary Market
 Municipal bonds are traded in the over-the-counter
market supported by municipal bond dealers across
the country.
 Markets are maintained on smaller issuers (referred to
as local general credits) by regional brokerage firms,
local banks, and by some of the larger Wall Street
firms.
 Larger issuers (referred to as general names) are
supported by the larger brokerage firms and banks,
many of whom have investment banking
relationships with these issuers.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-32
Municipal Bond Market (continued)
 Secondary Market
 The convention for both corporate and Treasury bonds
is to quote prices as a percentage of par value with
100 equal to par.
 Municipal bonds, however, generally are traded and
quoted in terms of yield (yield to maturity or yield to
call).
 The price of the bond in this case is called a basis
price.
 The exception is certain long-maturity revenue bonds.
 A bond traded and quoted in dollar prices (actually, as
a percentage of par value) is called a dollar bond.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-33
The Taxable Municipal Bond Market
 Taxable municipal bonds have their interest taxed at the federal level.
 Because there is no tax advantage, an issuer must offer a higher yield
than for another tax-exempt municipal bond.
 There are three reasons why a municipality would want to issue a
taxable municipal bond and thereby have to pay a higher yield than if
it issued a tax-exempt municipal bond:
i. Some activities do not benefit the public at large and municipalities
have to finance these restricted activities in the taxable bond market.
ii. The U.S. income tax code imposes restrictions on arbitrage
opportunities that a municipality can realize from its financing
activities.
iii. Municipalities do not view their potential investor base as solely U.S.
investors.
 When bonds are issued outside of the United States, the investor does
not benefit from the tax-exempt feature.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-34
The Taxable Municipal
Bond Market (continued)
 The most common types of activities for taxable
municipal bonds used for financing are:
i. local sports facilities
ii. investor-led housing projects
iii.advanced refunding of issues that are not permitted
to be refunded because the tax law prohibits such
activity
iv.underfunded pension plan obligations of the
municipality.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-35
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording, or otherwise, without
the prior written permission of the publisher. Printed in the United States
of America.

Copyright © 2010 Pearson Education, Inc.


Publishing as Prentice Hall
8-36

Você também pode gostar