The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

MUNICIPAL SECURITIES

Bonds are issued by state and local governments and by entities that they establish. These securities are popularly referred to as municipal securities, despite the fact that they are also issued by states and public agencies and their instruments. Municipal bonds also include bonds issued by the District of Columbia and any possession of the United States—Puerto Rico, the U.S. Virgin Islands, Guam, American Samoa, and the Northern Mariana Islands. An official statement describing the issue and the issuer is prepared for new offerings. Municipal securities expose investors to credit risk and are rated by the nationally recognized rating organizations.

There are both tax-exempt and taxable municipal securities. “Tax-exempt” means that interest on a municipal security is exempt from federal income taxation. The tax-exemption of municipal securities applies to interest income, not capital gains. The exemption may or may not extend to taxation at the state and local levels. Each state has its own rules as to how interest on municipal securities is taxed.

Because of the financial difficulties faced by state and local governments and their agencies in recent years, Congress authorized the issuance of a new type of taxable bond under the American Recovery and Investment Act of 2009. These bonds, dubbed Build America Bonds (BABs), come in two forms. The first type, called a direct payment BAB, is a taxable municipal bond. However, the issuer is subsidized for ...