Municipal bonds

Often the reason a given plant site is chosen is that special incentives have been offered by local authorities. In the mid-1960s, when money for financing was hard to obtain and interest rates were high, tax-free municipal bonds were an important lure. Tax-free means the investor does not need to pay taxes on his earnings. This means the bonds can be sold at lower interest rates and the company saves money. In 1967, 1,500,000,000 worth of these industrial bonds were issued. In 1968 the Department of Internal Revenue announced that in the future bonds used to finance private industry would be taxed regardless of who issued them. However, since then various loopholes have developed. Municipal bonds used to finance public projects such as schools, roads, and fire stations are still not taxed, since many communities would be unable to finance these projects at commercial interest rates. 

District heating systems are often financed by municipal bonds at low interest rates, to be repaid over a 30- to 40-year period. This makes the annual cost per home competitive with or less than that of conventional heating systems. 

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Tax incentives were utilized as part of the financing package to build the Modesto tires-to-energy power plant. Tax-free municipal bonds were issued to borrow money from investors to build the plant. Utilizing tax-free municipal bonds allowed borrowing the money at a lower interest rate. 

Stockholders and lenders. The public firm receives savings from individuals as well as pension and insurance funds to invest. In return, the stockholder receives dividends or interest and stock appreciation. The government firm can return a surplus to the government treasury or perhaps constitute a burden to taxpayers. If the firm did not exist, this capital would be invested elsewhere, perhaps in home mortgages, municipal bonds, commercial paper, or government securities. 

Interest during the construction period and/or the cost of borrowing capital and paying it back, as with a municipal bond. This can be estimated to be 6% of the TM cost. Legal fees. An estimate might be 1% of the TM cost. 

The nation s first saline water conversion plant to treat an entire municipal supply, built for the town of Buckeye, Ariz., went into operation early in September 1962. It has the capability to reduce water of 2200 p.p.m. total dissolved solids to 500 p.p.m., at a rate of 650,000 gallons per day. The plant was financed by a 305,000 issue of 25-year, 41/2% water revenue bonds sold at competitive bidding through normal municipal bond channels. No federal or state funds were utilized in the financing of this plant. 

The two curves for cellulose alcohol represent the economics for 100% investor equity capital and for municipal bond financing. Also shown on the figure is the projected selling price for ethanol at 7% and 5% inflation rates. The cellulose alcohol curve with municipal bond financing shows the effect of interest losses prior to the first operating year. The third-year selling price is more representative of actual economics. 

In an unadulterated world, MV analysis would simply be applied to after-tax return, risk, and correlations to produce tax-efficient portfolios. Regrettably, tax law is complex and there are a variety of alternative tax structures for holding financial assets. In addition, there are tax-free versions of some instruments such as municipal bonds. Further complicating the analysis is the fact that one must know the split between ordinary income and long-term gains to forecast MV model inputs. This muddles what would otherwise be a fairly straightforward portfolio-allocation problem and requires that tax structure subtleties be built into the MV framework to perform tax-efficient portfolio optimization. 

Understandably, investors would be reluctant to invest in a company if its profit expectations were no greater than that of a virtually riskfree investment in federal government bonds or an investment in tax-free, insured municipal bonds. Investors will expect a return commensurate with the risks of the business proposal under consideration. At some time in their history, almost all companies will borrow money from investors, who will review their business plans and their budgets closely. 

But Chuck Miller, chair of the Housing and Redevelopment Authority made an interesting proposal the housing authority would be the prison s developer and the state would take over maintenance and operation upon its completion (Holyfield, 1995a). The town would finance the project by issuing tax exempt municipal bonds the state would lease-purchase and, eventually, own the facility. Locally, the suggestion drew upon a successful precedent Big Stone Gap had used the same method... 

A wide variety of swap contracts have been traded in the market. Although six-month LIBOR is the most common reference rate for the floating-leg of a swap making semiannual payments, for example, three-month LIBOR also has been used, as well as the prime rate (for dollar swaps), the one-month commercial paper rate, the Treasury bill rate, the municipal bond rate (again, for dollar swaps), and others. 

Any investment carries risks, no matter how safe and secure the investor thinks it is. Even municipal bonds, long called "widow and orphan investments," can be risky—consider the case of Orange County, California s bailout in 1995—tossing aside the idea that an investment in bonds equals an investment in safety. 

Municipal bonds are bonds issued by states, counties, cities, and other divisions to finance the building and servicing of public facilities, such as airports, hospitals, roads, bridges, tunnels, power plants, and water systems. The bond s interest is federal and sometimes state tax-free to encourage investment in projects that are felt to be for the greater good. 

This constant demand for tax-exempt instruments means prices for municipal bonds tend to remain steadier,- municipal bonds tend to have more subdued highs and lows than other fixed-income securities. In order to compare a municipal bond s return with that of other types of fixed-income securities, it is... 

One characteristic generally associated with bond buyers is that they are older, more conservative, and more sophisticated with respect to investing than the rest of the investing public. This is especially true regarding municipal bond investors, who are often retirees who may have as much as 90 percent of their portfolios allocated to these securities in order to take advantage of the tax strategies. These savvy investors also prefer access to substantial information before making a purchase. 

But are these folks really going to log on to the Internet to buy bonds The answer is yes. According to the 2000 census (http //www.census.gov), there are more than 82.8 million people in the United States between the ages of 35 and 54—this is up 32 percent, or 20 million, from the 1990 census (and all but the 35-year-olds are considered by the U.S. Census Bureau to be Baby Boomers). Thus, the traditional "beginning investor" audience for Treasury and municipal bonds—those making the... 

John Durrett, CEO of municipal bond broker MuniDirect. com, asserts that most investors still feel that bonds are more difficult to understand than stocks, which is not true. "Due to the clear-cut information that s out there, making a bond purchase based on available information is much, much easier than that for stocks, with their charting, tracking, research, and other moving parts," Durrett says. 

The year 2001 was a good one to own bonds, with returns on fixed-income funds in the plus column as declining rates pushed prices of some bonds up. Through October 2001, the average taxable bond fund returned 5.59 percent and the average tax-exempt municipal-bond fund returned 5.31 percent, according to Upper,- meanwhile, the average diversified U.S.-stock fund fell 19.38 percent. 

Incidentally, fixed-income securities issued by the federal government such as Treasury bills, notes, and bonds are not rated. Since these bonds are backed by the full faith and credit of the U.S. government, they are considered to be relatively free of default risk. Municipal bonds, however, such as those issued by a city or a state or other local authority, many times are rated, since the finances of local governments can and do change. 

An important aspect to municipal bonds is that interest from those bonds is in most cases free of federal income taxes. While they generally pay a lower interest rate because of this... 

Yes, it s true. Municipal-bond holders used to expect virtual immunity from the IRS, but now that has been significantly challenged. The agency can now revoke the bonds tax-exempt status and tax muni investors when it finds that the bonds don t comply with tax laws and it can t reach a settlement with the issuer. The IRS can do this when it learns that the proceeds of a municipal bond offering have been misappropriated. Also, when a local government fails or refuses to pay certain taxes, the IRS will go no only after the municipality, but also the bondholders. 

Investors must be aware that the interest payments from municipal bond mutual funds that own private-activity bonds can push the investor s income to a level where he or she at least has to file an AMT form and possibly has to pay the tax itself. Congress estimates that as many as 8.5 million people will have to pay the AMT by 2007, up from just 605,000 in 1996. 

Municipal bonds, affectionately known as "munis," are one of the best instruments ever created for investors. They are the be-all, end-all, civic-minded type of investment Your hard-earned dollars go to building government and public structures and services, like highways, bridges, sewage treatment plants, airports, and hospitals. 

And besides doing your public-service part, the bond s interest is federal and sometimes state tax-free to encourage investment in the bonds financing these projects. What more could you ask for The federal and state governments don t tax each other s bonds, so you don t have to pay federal taxes on the interest you earn on municipal bonds. And, in many states, the income is also exempt from state taxes. 

Also, keep in mind that because of municipal bonds tax-exempt quality, local governments issue bonds with lower yields, knowing that they can still attract interested investors. You generally don t shop in the municipal market based solely on yield, you look for credit quality, maturity, and other factors. 

As an illustration, here is how you calculate the taxable equivalent yield (TEY) for municipal bonds. Let s assume a federal tax rate of 25 percent and a tax-exempt yield of 5.45 percent. First find the reciprocal of your tax rate ... 

Another factor to consider is whether you live in a state where municipal bonds are free from both federal and state taxes—this... 

The other class of municipal bond is revenue bonds, affectionately known as "revs." Revs are backed by the revenues generated by a specific project s user fees. The proceeds from the bond sale are used to build or maintain a project. User fees include tolls taken on a turnpike, bridge, or tunnel, override fees paid by attendees at civic or convention centers (you ve no doubt had to pay these at any new convention center), or airport landing fees. 

Insured municipal bonds have become more and more common. With an insured muni, an insurance company guarantees that the bond s interest or principal payments will continue even if the issuer becomes insolvent and cannot pay. Some investors like the added peace of mind that comes with buying insured municipal bonds. For this added peace of mind, they are also willing to forgo some yield. 

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