Learn the details behind general obligation municipal bonds – what they are, why they are created, and how they work – with this illustrated video by Fidelity.

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Many people purchase municipal bonds as part of their overall investing strategy, but there’s quite a story behind how they are created, how they work, who’s involved. The municipal bond process can be a complicated one, so we’ll try to simplify it for you.

Our story begins by paying a visit to Anytown, USA. Anytown is a great place to live. There’s a thriving cultural scene, good schools, and a strong business environment. It’s no wonder that many families have moved here. But, with lots of families now living in Anytown, the schools are bursting at the seams. The mayor, town council, and school district leaders all agree that a brand new school is needed, in addition to expansions to some of the existing school buildings. But, at an estimated cost of $30,000,000, how will the town pay for it?

The town leaders come up with a plan to raise these funds by issuing bonds. This means that Anytown will borrow money from investors with the expectation of paying them back, with interest, over time. The people who will actually use the school building in the future will also be the folks paying for it. Anytown will use property tax revenues to repay the investors, backed by the full faith and taxing authority of the town. This is called a “general obligation municipal bond.”

But, things can’t move forward just yet. Voter approval of the proposal is required. So, a bond proposal is developed and put on the ballot, as part of an election. The votes are tallied and the proposal is passed.

At this point in our story, some new characters enter the scene: the underwriter, the bond counsel, and in most cases, the financial advisor. The financial advisor helps Anytown make decisions regarding the bond issue and works with the underwriter to determine pricing and distribution to investors. The underwriter acts as a liaison between the town and potential investors when bringing the bond issue to market.

An underwriter can be chosen in two ways: via competitive sale or negotiated sale. The leaders of Anytown decide to go the competitive route, and put the bond issue out to bid. This is where the bond counsel, Smith & Jones Law Firm, enters the picture. Smith & Jones prepares the bond documents, including the Official Statement, and since Anytown has chosen the competitive route, a Notice of Sale. The Official Statement contains all the information a prospective investor needs in order to invest in Anytown’s bond issue. The underwriter will review the Official Statement and decide whether to bid on the bond. The bond counsel also writes the legal opinion, which provides justification and law for the tax exempt status of the issue and ensures that the bonds are valid and binding obligations for Anytown. The firm does not comment on the investment merit of the bond issue.

Now that the legal opinion is in place, the Notice of Sale can be completed and posted. ABC Investment Bank sees the ad and is interested in underwriting it, with the ultimate goal of buying the muni bond issue from Anytown, and reselling it to investors. Before submitting a bid, however, they would like to invite other investment banks to participate with them, so they decide to form a syndicate and act as the syndicate manager. Forming a syndicate will allow the bank to share the marketing and distribution duties, as well as some of the financial risk of underwriting the bond issue.

Two banks, JKL and XYZ, agree to join ABC Syndicate and they submit a bid.

Back at Anytown town hall, the bid is reviewed, along with several others up for consideration. After much deliberation, the bond issue is awarded to the syndicate formed by ABC Investment Bank because they turned in the lowest borrowing cost. The syndicate goes to work as the underwriter, reaching out to individual and institutional investors to determine their interest in purchasing the bonds […]

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Municipal bonds, also known as munis, are debt securities issued by local governments or their agencies to finance infrastructure projects such as schools, roads, and water systems. These bonds are popular among individual investors seeking tax-exempt income and a way to support their local communities.

One of the main advantages of municipal bonds is their tax-exempt status. Interest income earned from munis is generally exempt from federal income tax, and in some cases, state and local taxes as well, making them an attractive investment option for investors in higher tax brackets. The tax benefits associated with municipal bonds allow investors to potentially earn a higher after-tax yield compared to other taxable investments.

Municipal bonds come in two primary forms: general obligation bonds and revenue bonds. General obligation bonds are secured by the issuer’s full faith and credit, backed by its taxing power. This means that the issuer has the authority to raise taxes to meet its debt obligations. On the other hand, revenue bonds are backed by the revenue generated from a specific project or facility, such as toll roads, airports, or hospitals. Investors in revenue bonds rely on the income stream generated by these projects to receive interest and principal payments.

When investing in municipal bonds, investors have the option to choose between short-term and long-term bonds, depending on their investment goals and risk tolerance. Short-term municipal bonds generally have lower yields but offer enhanced liquidity, as they typically mature within one to three years. Long-term municipal bonds, on the other hand, have longer maturities, ranging from ten to thirty years, and usually offer higher yields to compensate for the longer investment horizon.

It’s important to note that municipal bonds are not risk-free investments. The credit quality of the issuer plays a significant role in determining the risk associated with these bonds. Municipalities with stronger financial positions and credit ratings are considered less risky, while those with weaker financial standings may present higher risks to investors. Rating agencies assess the creditworthiness of municipal bonds by assigning ratings such as AAA (highest quality), AA, A, and below investment-grade ratings.

Before investing in municipal bonds, it is wise to carefully analyze the credit quality, market conditions, and the specific risks associated with each bond. Additionally, diversifying your municipal bond portfolio can help reduce risk by spreading investments across different issuers and sectors.

Fidelity Investments, a leading global asset manager, offers a wide range of municipal bond investment options to individual investors. The firm provides comprehensive research and analysis tools to assist investors in making informed decisions about investing in municipal bonds. Fidelity’s platform allows investors to conveniently buy and sell municipal bonds, review bond performance, and access educational resources to enhance their understanding of these investment vehicles.

In conclusion, municipal bonds are debt securities issued by local governments to fund public projects. They offer tax advantages to investors and allow individuals to support their local communities while generating income. However, like any investment, investors should carefully evaluate the risks associated with municipal bonds and diversify their portfolios to manage risk effectively. By partnering with a reputable investment firm like Fidelity, investors can gain access to comprehensive research and tools to navigate the complexities of the municipal bond market.