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Finance: What is a Muni Bond? 24 Views

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What is a muni bond? Muni bonds are bonds issued by the government. They are used to raise the money required to pay for government responsibilities like schools and roadways. Because of their nature and purpose, they are not taxed, so they make for pretty good investment opportunities for people in high tax brackets.

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finance a la shmoop. what is a muni bond? all right well this is a moonie bond or
00:09
band as they say in America. all right and this is a muni bond or municipal [people in orange robes sing together]
00:18
bond. yeah that muni thing there is for short.
00:20
well muni bonds function differently from the way in which normal corporate
00:24
bonds function in America. municipal bonds are financing that cities do to

00:30
raise money. think local think townhall meetings like old folks arguing about
00:35
where to install new speedbumps. think angry local residents berating their
00:40
federal senators .though this stuff might sound like small change local government
00:45
is the backbone of the US of A. without your lovely local government you
00:50
wouldn't have sewer systems,or local roads, or that one Park you and your
00:55
friends hang out at when you're up to no good. yeah we know we've seen you on the
00:59
video camera. alright so muni bonds are a must-have in [pictures of people in parks]
01:02
society ,not a nice-to-have. and as a result we treat them specially.
01:06
that is we don't tax the interest they throw off and that's a big deal. a
01:10
corporate bond yielding 7% to investors who pay 40% tax gives investors a net
01:17
yield after taxes of 1 minus point for their times seven equals four point two
01:23
percent. well a muni bond can pay just four point three percent - ie slightly
01:28
more net than a corporate bond with the same risk and be a good deal for its
01:33
buyers. that difference of two point seven percent in interest is a huge
01:37
difference over time in the cost of capital from municipalities already
01:42
strapped for cash trying to raise money desperate to get that new sewer system [equation showing bond return rates]
01:46
in place for well you know a whole variety of reasons. and you know use that
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rule of seventy two thing you here remember you divide the 2.7 and 72 ,yah
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that's how many years it takes to double, okay, but what happens when a Muni can't
02:00
pay its bills, well in corporate America the bondholders just take possession of
02:04
the company operate it with new management pay off the debts they're
02:07
owed and well then sell it more or less. but with muni bonds you can't just
02:11
auction off a sewage treatment plant or a Reservoir Dam on
02:15
eBay. they'd sell it a huge discount for what money went into him like well maybe [ebay listing shown]
02:20
you sell them to a golf course developer or well maybe they just don't sell it
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all there are zero residual value and yes
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ouch. so muni bonds get treated with a little bit different perspective on risk
02:31
like the city is on the hook for them in different ways, and there are two basic
02:35
flavors of muni bonds as far as they're being backed. there's general obligation
02:40
bonds which are bonds backed by The Full Faith and Credit of the city, and then
02:43
there are revenue bonds backed only by sales expected to be reaped from a
02:48
specific project, say you know that new 8 story parking structure in the middle of
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town which charges you 40 bucks a day to park your car.
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well that 40 bucks or at least part of it would go back to repay the owners of [parking garage pictured]
03:00
the revenue bond. so why wouldn't you knee bones be backed in two different
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ways? well because investors like to know what happens if the city doesn't pay
03:09
back its bills. general obligation bonds are backed by the city's ability to tax
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its citizens. that's that under Full Faith and Credit thing. that is the
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general obligation bonds oblige- see that's that obligation thing- they oblige
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the entire city generally to pay its bills. like even if they have to double
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tax the rich people in the city hoping they don't move out you know pay back
03:32
the money they borrowed. if a city ever renigs well they'll lose that Full Faith
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and Credit from investors, and well good luck ever raising money again, or at
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least certainly at any kind of favorable rates. with revenue bonds the backing is
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narrower, the project is riskier, and usually the interest rates that come [types of muni bonds]
03:50
with it are higher. payment on these bonds comes from the revenue generated
03:55
from what the bonds were used to create. right like bonds to build a toll road or
03:59
another example here. thought it may be better than the parking authority thing
04:02
yeah okay okay. all right well the issuer can estimate fairly accurately the
04:06
revenue that will be generated from those tolls and then it's up to the [equation pictured]
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investor to decide if that revenue will be sufficient enough to service the debt
04:14
on the bond. and historically muni bonds are very safe .only a handful of muni
04:19
offerings in the US have ever not paid back everything .so in the scheme of
04:23
things munis are a good risk. at least they have been as Illinois in
04:27
California begin to Teeter on the edges of bankruptcy it'll be interesting to
04:30
see what happens to the creditworthiness of their big cities, and whether they
04:34
manage to climb back up to steady ground or enjoy a nice skydive you know - the
04:39
parachute. either way Muni balance will remain one of the most
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fundamental financial institutions of the US of A while a mooning bond well
04:46
that'll have to remain a personal fantasy. yes sounds look double o heaven. [person moons camera]
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