by Marc Prosser
Understanding how municipal bond offerings are structured is one of the first things you should do when deciding which bonds to buy. The structure of the offering generally refers to the interest rate and maturity date of the bonds included in the offering. Many factors and considerations go into each of these, so understanding both is a good place to start.
Coupon Rate
The interest rate paid on a bond when it is first issued is its coupon. This is also the amount of money the bond will pay out to the investor on a regular basis in interest. If you buy $10,000 worth of municipal bonds with a 4% coupon, then you will receive $400 each year that you own the bond.
Fixed-rate vs. Variable-rate Municipal Bonds
Municipal bond issuers can choose to issue bonds which carry a fixed coupon rate, a variable coupon rate, or a combination of both fixed and variable rate bonds. Fixed rate bonds are the easiest to understand because they pay the same income every year until the bond matures.
Variable rate bonds, which are also referred to as floating rate bonds or floaters, pay a rate of interest which adjusts periodically. Those adjustments are linked to indexes such as U.S. Treasury bond yields. Variable-rate bond structures can be beneficial to investors looking to hedge against inflation. Also, variable-rate bonds are less likely to lose as much of their value as fixed-rate bonds.
Callable Municipal Bonds
Deals structured with callable municipal bonds and step up coupon rates can minimize your interest rate risks while you hold the bond. This type of deal allows for a preset coupon rate to be used that will allow for increases in interest rates or coupon rate as the bonds mature. If you consider deals that are structured this way, keep in mind that if interest rates go down, the issuer can redeem the callable bond quicker. That could put a damper on your investment goals if you decide to reinvest the money you receive from the redemption if you have to do so at a lower interest rate.
Serial vs. Term Municipal Bonds
Municipal bond deals are usually structured with serial bonds, term bonds or a combination of both. Serials have yearly maturities, and the interest payments are made until the final maturity for serial bonds. Term bonds mature in a single year, often near the maturity date of the longest serial bond.
Because there are so many factors that must be considered about a municipal bond deal’s structure, it’s a good idea to consult with a professional. However, doing your homework on the above items beforehand is an excellent start.
