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Municipal Bond Forum
FMSbonds, Inc.'s Bond Forum™ is an exclusive opportunity for investors to submit questions and comments on the bond market or to respond to one of our articles.
To participate, just send us an e-mail. Be sure to include your name or initials and your state of residence. Posted e-mails may be edited for length and clarity. If you prefer a private response, please note that in your e-mail. Responses are provided by James A. Klotz, president and co-founder of FMSbonds, Inc., a municipal bond specialist for more than 35 years; Dr. Jay H. Abrams, chief municipal credit analyst; and other members of the firm as noted.
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Examine underlying credit worthiness
8/18/2010You have always advocated purchasing "high-quality, long-term bonds" for income-interested investors. Yet, a few years ago, insured bonds were rated AAA (not their underlying rating) and were touted and sold as high quality. We know what happened to the insurers and the bonds that were considered "high quality." Again, today, some bonds are being presented as AAA merely because they are "insured." These insurers could not cover defaults if they should occur, so why should the bonds carry that rating?
- A.G., FloridaYour point is well taken. Many of the bond insurers, formerly rated "AAA," have fallen from grace in recent years.
It is no longer a secret that the rating agencies, the bond insurers, along with most of Wall Street badly misjudged the risks associated with Mortgage Backed Securities.
The "AAA" bond insurers’ problems were not caused by their municipal bond portfolios, which for the most part contained solid credits prior to the insurance enhancement.
It should also be noted that, although downgraded, many of the insurers retain significant claims paying ability despite the fact they are not writing new business.
Hopefully, the rating agencies have learned from past mistakes and are now examining all the activities of the bond insurers before assigning them ratings.
Nevertheless, it is always prudent to examine the underlying credit worthiness of any security when contemplating your purchase.
Premium bonds often misunderstood
8/13/2010I bought long-term muni bonds last year with 5% to 6% coupons at below par value. They have returned regular income and appreciated in value. In six months, I receive a multimillion-dollar lump sum and want to purchase munis for income. If current prices don't change, then I would be buying bonds at a premium and building in a long-term loss. Should I buy anyway for the income or look for high-quality bonds that are nearer their par value?
- B.P., OregonIt is important to remember that buying a bond at a "premium" is not a "penalty." It simply reflects the appropriate yield for the current interest rate environment.
In fact, bonds trading above 100.00 typically offer the best values in the market. Ironically, this is the case because they are often misunderstood by individual investors who resist buying premium bonds because they perceive them as being more expensive than par bonds, misinterpreting the relationship between "dollar price" and "yield."
After quality considerations, yields are the key factors when evaluating the price of any bond. The dollar price is merely a mathematical function of the yield. Every dollar invested in a premium bond (including premium dollars) is working at the stated yields.
Premium bonds invariably carry a higher yield-to-maturity than par bonds of comparable quality, and if called, they will yield more to that call date than any par bond you could have purchased maturing in that year.
For more on premium bonds, click on the following article: "Hidden Gems in the Muni Market".
BABs excellent for retirement accounts
8/10/2010I understand it's not recommended that you use muni bonds in IRAs because taxes on traditional IRAs are already tax deferred. But I've been doing some out-of-the-box thinking about alternative IRA investments and wondered whether, if I did use muni bonds in a traditional IRA, the bond interest would be taxed since the bonds are already tax exempt?
- S.B., ColoradoAs you mentioned, tax-exempt bonds are not normally considered appropriate investments for tax-deferred retirement accounts such as traditional IRAs or 401Ks. This is primarily because all distributions from your IRA are subject to taxation regardless of the source, and tax-free bond yields are historically lower than those of
taxable securities.
Many investors, however, have taken advantage of the recently introduced Build America Bonds (BABs) program that allows the issuance of taxable municipal bonds that enjoy a 35% federal government subsidy.
These BABs offer the same degree of safety as traditional tax-free bonds but provide significantly higher yields. Accordingly, they are ideal investments for tax-deferred retirement accounts.
The following link will take you to an article that discusses the BABs program in further detail: "Popularity of BABs Bodes Well for Tax-free Bonds."
This report is produced solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. This report is based on information obtained from sources believed to be reliable but no independent verification has been made, nor is its accuracy or completeness guaranteed.