The Entertaining and Highly Informative
Lebenthal Glossary
Accretion
Accrete is what a zero coupon bond does when, instead of spinning off interest from a coupon, it plows the interest back into the bond every six months so that interest can earn interest, build and rebuild on itself, until one day that zero coupon bond has grown in value—accreted—and becomes redeemable at par.
Accrued Interest
It’s like buying a house and paying for whatever oil is left in the tank. An adjustment on your confirmation for the portion of the next interest payment that is due to the previous owner. When you buy a bond, you shell out the interest the previous owner is entitled to. When you receive your first interest payment, you get it all back in the full six months interest for a bond you held only part of the six months. It works both ways. W hen you sell a bond, you’re the one receiving accrued interest from the new buyer.
Additional Bonds Test
The level at which the earnings of a project built by bonds must cover debt service before additional bonds can be floated.
Advance Refunding
The refunding now of a bond even though it is not yet callable. To do that, an issuer floats new bonds and sequesters the money in U.S. government securities to pay off the old debt when it does become callable. The old bonds, having been advance refunded and taken off the books of the issuer, usually step up to triple-A.
Alternative Minimum Tax
Are you a big giver? Do you have substantial deductions for charitable giving, incentive stock options, state and local taxes, and capital gains that are treated preferentially at tax time? Individuals with the kind of shelters and write-offs the government calls “preferences”—and that includes the interest from so-called private activity bonds—have to compute their taxes two ways: the regular way, taking all the allowed deductions and exclusions, and the Alternative Minimum Tax method, adding the deductions and exclusions minus a $69,950 gimme for couples and $46,200 for singles ($34,975 for marrieds filing separately). The taxpayer will end up owing whichever is greater: the regular 15 percent, 25 percent, 31 percent, 35 percent tax rate on the first calculation; or 26 percent of the AMT add-back calculation (minus the aforementioned gimme) on the first $175,000 ($75,000 for marrieds filing separately) and 28 percent above that.
Amortization of Premium
Let’s say you bought a bond at a 110, and it paid off at 100 at maturity. Where’d the premium go? Why, you got it back bit by bit every six months in the coupon, part of which was real interest being earned and part of which was return of principal. In BondSpeak, it’s called amortizing the premium. It’s actually skimming your own money that you laid out for the premium back into your own pocket.
AON (All Or None)
It means, if we offer a $125,000 block of bonds, you have to buy the whole block—all or none.
Appreciation of Discount
The flipside of amortization of premium. It’s the steady growth in a discount bond as it slouches toward maturity to reach its full face value.
Arbitrage
In munis, positive arbitrage would occur when an issuer borrows in the low-cost, tax-free bond market, turns around, and invests bond proceeds in higher-yielding taxable Treasuries, and tries to pocket the change. Our strapped municipalities would do it all day long, were it not for the 1986 Tax Reform Act requiring issuers to rebate positive arbitrage earnings to the IRS or lose the exemption on its municipal bonds.
Ask
Ask is the price we charge when we sell you a bond, as opposed to bid, the price we would pay when we buy a bond from you.
Authority
A public body created by a state or municipality to provide for water, housing, transportation, or other community needs and authorized by the legislature to borrow in the tax-free bond market to build the necessary facilities. The name of the state or municipality may be part of the title of the bond. But authorities usually do not have the power to tax. So their bonds are generally secured solely by revenues and charges to the public for using the facility.
Barbell
A strategy for diversifying maturity dates between a bunch of short bonds coming due in two, three, four, five years (for their liquidity) and a bunch of long bonds maturing down the road (for their superior yield), leaving the middle range of maturities empty.
Basis Point
Even though a basis point is 1/100th of a percent—for instance, the difference between a bond yielding 5.99 percent and 6.00 percent—professional bond traders dealing in the millions will kill for one or two of those basis points.
Bearer Bond
In the old days, when municipal bonds came in coupon, no-name, form made “payable to bearer,” anyone could cash in their coupons and the bond itself at the end, no questions asked. In 1983, new issues in bearer form were outlawed. Even though a few are still floating around, don’t kid yourself. All redemptions are reported to the IRS on form 1099B.
Bid
An offer to buy a bond at a stated price. It’s the price you would get selling your bonds to us. For the price we’d turn right around and offer to sell that bond to someone else, look up Ask.
Bond Bank
Sometimes, instead of selling its bonds directly to the public, a small, obscure municipality will borrow from a state bond bank. The bond bank will then issue its own better-known bonds and pay debt service from the pool of interest and principal the bond bank is collecting from the participating localities.
Bond Buyer Index
There’s the 20-Bond Index, the 11-Bond Index, and the 25-Bond Revenue Bond Index, all published by the Bond Buyer, the municipal bond industry’s trade paper. Each index is an average of the yields to maturity of representative municipal bonds and purports to answer the burning question, where’s the market?
Bond Fund
A pool of bonds for pools of people of similar investment objectives, offering the flow-through of tax-free income, diversification, reinvestment of dividends, and professional management of your investment in the tax-free bond market. Viz. a mutual fund of municipal bonds.
Bond Indenture
The issuer’s covenant with the bondholder setting forth all rights of the bondholder and all obligations of the issuer.
Book Entry
Book entry, you know, just like your money market account, your mutual fund shares, and U.S. T-bills. When you buy a book-entry municipal bond, there is no physical delivery, because there is nothing to deliver. No certificate. No bond to stick in your vault or take out when you decide to sell. Purchases, sales, transfers, even the pledging of bonds as collateral, are simply made via computerized book entry without the redundancy of the bond certificate traveling back and forth in the mail.
Broker
Please, not broker. Nobody’s called a broker anymore. At Lebenthal, your personal account executive is your connection to the municipal bond market and the world of finance, and an all-around good egg.
Call, Call Date, Call Price, Call Risk
What an issuer does when it exercises its right to redeem a bond prior to maturity, pay you off, and bump you out of the picture. The terms of the call provision, such as call date, call price, or the circumstances under which bonds may be called, are spelled out up front and in full in the Official Statement.
Certificate of Participation
Instead of issuing bonds for a new municipal facility, the municipality commissions an entity to build the building and lease it back to the town. The entity lays off its right to the rental payments on third parties, namely investors in certificates of participation (COP). The rent flows through to them as COP interest. COP interest is tax free, just like ordinary municipal bond interest. Except for one thing. The revenue source for that interest, the municipality’s lease obligation, must be reappropriated every year in the municipality's annual budget.
Clip Coupons
BondSpeak from the old days when municipal bonds came with coupons attached—like tiny, postdated, interest checks, payable to bearer, to be clipped on each interest payment date and deposited in your bank for collection.
Closed-End Fund
This is a mutual fund that sells a fixed number of shares and does not add to the pot whenever new shareholders want in and does not buy back shares as shareholders want out. Instead, shares are traded on an exchange in the so-called “auction process,” where the price people are willing to buy and sell at determines the market—not the asset value of the underlying securities.
Coupon Rate
Coupon rate tells you the interest a bond is paying right along. Coupon and coupon rate are still used for the bond’s nominal interest rate.
Coverage
The number of times by which the earnings of project cover what’s needed to pay interest and principal on an associated revenue bond.
Credit Risk
The relative assuredness of receiving your interest right along and getting back face value at the end.
Current Coupon
An interest rate on a new issue or old issue fetching a price pretty close to par.
Current Yield
Current yield is how much you are earning here and now and every time you clip a coupon. It does not tell the whole story of how hard your money is working, because it does not take into account any appreciation of discount or amortization of premium at maturity.
CUSIP Number
Every coupon rate and every maturity date of every municipal bond has its own distinctive fingerprint—a nine-digit identification number assigned to it by the Committee on Uniform Securities Identification Procedures (CUSIP).
Dated Date
The official issue date, when interest on a new issue begins accruing.
De Minimis Market Discount Tax
Why glossaries are boring: because they can’t explain everything and shouldn’t try. Market discount is the discount that comes from a falling bond market rather than an original issue discount that comes from the issuer. The gain on an original issue discount is tax free. The gain on a market discount is subject to tax: capital gains tax, if it doesn’t exceed a certain amount. Ordinary income tax if it does. And that certain amount is the de minimis amount.
De Minimis Rule
Basically, if the discount from issue price at the time of purchase was greater than $2.50 for each full year between the date you paid for the bond and its maturity date, the market discount will be taxed as ordinary income. For more on how this impacts your investment in market discount bonds, call us. 1-800-425-6006.
Dealer
Dealers, as opposed to brokers, act as principals. For a moment in time, we dealers own the bonds we offer for sale, even if we have to buy them from somebody else and turn right around and sell them to you. We make our money on the spread between bid and ask.
Debt Ratio
The ratio of a municipality’s debt to its tax base, population, per capita incomes. A measure of ability to pay. Low is good.
Debt Service
The dollar amount of annual interest and principal due on outstanding bonds—this year, next year, and, we always like to know, in the year of maximum annual debt service due.
Debt Service Reserve Fund
A kitty that can be funded from bond proceeds or from tax collections or other revenues that the bond indenture requires to be maintained at a certain level—often an amount equal to one year’s maximum annual future debt service.
Default
Like surrender in war, nonpayment of debt service in municipal bonds is unspeakable. A tabulation by Fitch IBCA reports that by March 1999, general purpose tax-supported debt issued between 1979 and 1986 had a cumulative default rate of only 26/100ths of 1 percent. This table comparing muni defaults to corporate defaults was submitted in evidence to a congressional committee holding hearings on a bill to require the rating agencies to base their ratings on the likelihood of default. The bill, the Municipal Bond Fairness Act (HR 6308), got nowhere. But here is its legacy: the default rate for municipal bonds is lower than that of identically rated corporate bonds.
Cumulative Historic Default Rates (in percent) |
||||
Rating Categories |
Moody’s |
S & P |
||
|
Muni |
Corp |
Muni |
Corp |
Aaa/AAA |
0.00 |
0.52 |
0.00 |
0.60 |
Aa/AA |
0.06 |
0.52 |
0.00 |
1.50 |
A/A |
0.03 |
1.29 |
0.23 |
2.91 |
Baa/BBB |
0.13 |
4.64 |
0.32 |
10.29 |
Ba/BB |
2.65 |
19.12 |
1.74 |
29.93 |
B/B |
11.86 |
43.34 |
8.48 |
53.72 |
Caa-C/CCC-C |
16.58 |
69.18 |
44.81 |
69.19 |
Investment Grade |
0.07 |
2.09 |
0.20 |
4.14 |
Non-Invest Grade |
4.29 |
31.37 |
7.37 |
42.35 |
All |
0.10 |
9.70 |
0.29 |
12.98 |
Derivative
A financial contract used for hedging, leveraging, and managing risk by taking a position in an asset without having to invest dollar for dollar in the actual asset. Success or failure depends on how closely the derivative tracks the reference asset and is magnified in direct proportion to the leverage involved: the cost of the contract relative to the amount of the asset the contract is for.
Discount
A bond sells for less than the amount you’ll get back at maturity because it was either issued at an original issue discount or has fallen in price in the secondary market. Part of the investment return from a discount bond is coupon interest. Part is the gain from cashing in at full face value at maturity.
Dollar Bond
A bond that trades so frequently it is handier to quote it in dollars and cents, like meat and potatoes, than by its yield to maturity.
DTC
The Depository Trust Company in New York City, an industry-owned cooperative, is the world’s largest custodian of corporate and municipal securities. DTC holds in its vaults one jumbo security for the whole issue or for each maturity. We sell you a piece of the issue. We send you a confirmation. We record the transaction on our books, and ownership is transferred via book entry from our account at DTC to a separate Lebenthal customer account at DTC. On an interest or principal payment date, DTC credits Lebenthal, and we in turn credit your Lebenthal account.
Duration
A term that is totally removed from people’s experience but very useful, like “light-years” to measure distance to the stars or “10!” to quantify pulchritude. Duration weighs the price volatility of a municipal bond, and the greater the duration, the greater the volatility. If duration is one way to express the relative vulnerability of your portfolio to market risk, then duration is a good thing to know (even though there may not be two fellows in the bond business who can tell you how to set your clock by it).
ETF
“E” for exchange, “T” for traded, “F” for fund. An exchange traded fund is not a mutual fund at all, but a stock, traded on exchanges at the net asset value of the securities in the portfolio, subject to the customary brokerage commission. When the portfolio consists of tax-free municipal bonds, that ETF amounts to nothing less than tax-free dividends from a common stock.
Escrow to Maturity
Sequestering the funds now—locking them up with a trustee for the sole purpose of redeeming a bond issue way down the road at maturity, as opposed to its call date. Any existing features for calling in bonds and redeeming them prior to maturity may still rule.
FINRA
Stands for the Financial Industry Regulatory Authority, merged from the NASD and New York Stock Exchange’s enforcement arm. FINRA is responsible for oversight and regulation of all securities firms dealing with the public, including licensing, training, registration, arbitrations, compliance, and fair dealing.
Flat Tax
A consumption tax proposal that would tax the income you spend but not the income you don’t spend. Thus, unspent income invested in bank CDs, Treasuries, corporate bonds, as well as municipal bonds, would be untaxed until spent. If such a flat tax came to pass, municipal bonds would still be tax free, but they would no longer be the only tax-free investment in town.
Flow of Funds
Where the bondholder stands in line with respect to other claims on tolls, fares, and nickels in the meter pledged for debt service.
Full Coupon
Any coupon rate high enough for a bond of a given maturity to sell at par or premium.
Full Faith and Credit General Obligation
This is as close to the absolute as you can get on paper. This is the ultimate pledge of using all the issuer’s resources—and taxing power—to make good and pay you back. Heaven help a municipality that hands out such a pledge lightly.
Gross Revenues
All the revenues, everything in the issuer’s cash register. Take the issuer of a hospital bond, for example. Gross revenues would include patient and third-party payments, income from investments, concessions, rentals, unencumbered gifts, grants, donations, etc. Gross revenues are the starting point from which the payment of operations, maintenance, and debt service will then be prioritized and meted out.
Guaranteed
When a revenue bond is also backed by the unqualified taxing power of a state or local government, or when one political entity stands behind the bonds of another with its full faith and credit and taxing power, then, and only then, is the word “guaranteed” used.
Investment Grade
Bonds that are rated in the top four ratings as follows:
Fitch IBCA Moody's Standard & Poor’s
AAA, AA, A, BBB Aaa, Aa, A, Baa AAA, AA, A, BBB
Ladder
A strategy for staggering maturities sequentially (like ladder rungs), so you have bonds coming due and money coming in—to live on, spend, reinvest—commencing in X number of years and regularly thereafter.
Letter of Credit
A form of credit enhancement in which a bank or other financial institution guarantees payment of debt service that is limited to the expiration date of the L.O.C., usually five or so years. If the L.O.C. is not renewed by the institution or one of comparable rating, the bonds must be called.
Leveraging
Augmenting an investment with borrowed funds to goose return by an amount hopefully greater than the cost of the ante. Hint: don’t try to leverage by buying municipal bonds on margin. The cost of borrowing to buy or carry tax-free municipal bonds is not deductible.
Liquidity
Turning a security into cash with minimal loss. Put $1 in. Take $1 out when you need it. Now that’s liquidity.
Mandatory Call
The circumstances—unexpended bond proceeds, mortgage prepayments, insurance reimbursement, declaration of taxability—under which a bond must be called by the issuer. Not may, must.
Market Discount
When the price you pay for a bond is less than the original issue price, and the discount comes from a falling bond market. The gain at maturity or on sale for a market discount is treated one way by the IRS and another way for an original issue discount that comes from the issuer (in which case, it isn’t taxed at all).
Market Risk
The vulnerability of any fixed-income investment to changing interest rates in the economy and possible loss in value if sold before maturity.
Marketability
Liquidity is getting out what you put in. Marketability is the availability of ready buyers, the ease of selling your bond, if, as, and when you want your money—depending always on its current market value.
Markup
The amount of spread between bid and ask. In other words, between what a dealer pays for the bond and what he or she offers to sell it at.
MSRB
The Municipal Securities Rulemaking Board, the body that writes the rules for regulating the underwriting, buying, and selling of all municipal bonds.
Muni
The short, friendly handle for the municipal bonds of our great American states and their counties, cities, towns, and political subdivisions and authorities—and Puerto Rico, as well. As a commonwealth, the interest income from Puerto Rico munis is tax free federally as well as in all states of the Union. The same holds true for Guam and any other commonwealth, territory, or possession of the United States.
Municipal Bond
A municipal bond is evidence of the collective debt of a community. It is a promise to pay a fixed sum of money on a definite date in the future at a fixed rate of interest. It shows that some municipality needed money for the public good. You can’t get up in the morning, take a shower, a subway, a bus, go under the river, or over the bridge without a municipal bond touching your life. And the interest is tax free, federally, and free of state and local taxes in most states of the Union where the bond was issued.
Municipal Bond Insurance
An insurance policy guaranteeing payment of municipal bonds. The insurer’s obligation to pay principal and interest on defaulted bonds in full and on time is noncancelable, unlimited, and unconditional. Even without the third-party endorsement of triple-A ratings, the insurance could prove of practical value in an economic downturn.
Municipal Notes
Notes are short-term borrowings for a year or less to tide a municipality over during gaps in cash flow. They are issued in anticipation of taxes to be collected (TANS), revenues to be received (RANS), or from the proceeds of a long-term bond sale to be held later on (BANS).
Net Revenues
Revenues actually available for debt service after payments, such as O&M, that might come first, spelled out in the Flow of Funds.
Odd Lot
Could be a block of bonds under $25,000, $100,000, $1,000,000. Depends on the house you’re dealing with.
Official Statement
The indenture is the bondholder’s contract with the issuer, setting forth the terms of the deal. And its key provisions are also found in the Official Statement, an abundant disclosure document we are required by securities law to send you when you buy a new issue in the primary market. What there really ought to be is a law making sure you read it.
Open-End Fund
An investment company that is constantly selling shares and adding to portfolio as new money comes in and redeeming shares as money goes out. If actively managed, it doesn’t just sit there waiting for bonds in the portfolio to mature, but buys, sells, holds, and trades in an attempt to fulfill the fund’s objective.
Optional Call
The right of an issuer to redeem bonds at a certain date and at a certain price before maturity. Other call features may exist, but the optional call is the one that must appear on your confirmation.
Original Issue Discount
Although individuals may go for juicy coupon rates at par, one or two or more maturities in a new issue may come with lower coupon rates at discounts. (To give institutional investors and some individuals the potential for capital gains.) The accretion of original issue discount is considered a part of total return coming from the issuer and, as such, is tax free. The gain from any market appreciation on top of normal accretion is subject to the applicable tax.
Overlapping Debt
Debt burden is not just your municipality’s own bonds but the bonds of your school district, your county, and any other overlapping jurisdiction that local taxpayers are responsible for.
Par Call
The scheduled date a bond becomes callable at par with no premium for bumping you out of the picture early.
Par Value
The face value of a bond at maturity: 100 percent!
Performance
It can be good or bad. Performance is the bond trader’s success or failure at making money in the bond market, buying, selling, and trading opportunistically.
Premium
A bond whose price is above par. All it means is that a bond quoted to you at 105 is selling at 105 percent of par, or $1,050 for each $1,000 of face value.
Premium Call
This is really throwing you a bone. The first optional call date is often at a premium, to compensate you for having to give up a bond with a big, beautiful interest rate.
Pre-Re
Shorthand for a bond that has been advanced or pre-refunded.
Pre-Sale Order Taking Period
A one- or two-day period during which retail investors, like you, as opposed to big financial institutions, have first crack at a new issue. Still doesn’t leave much time to noodle on it.
Price to Par Call
Callable bonds must be quoted and offered at the “worse.” The “worse” is the lesser of yield to maturity, yield to the premium call, or yield to the par call. If by some stroke of luck the bonds do remain uncalled and do go out to maturity, the investor would wind up with a higher return. Gravy. Found money!
Prior Lien
This dictates who has first claim on the issuer’s resources. You, the bondholder? Or someone else?
Public Offering Price
On the bond side, it is the initial offering price of a new issue while the issue is still being offered in the “primary market,” and the price is the same to one and all. For the shares of an investment company (mutual fund, unit investment trust), public offering price is price at which the shares must be priced and sold.
RAN, TAN, TRAN, BAN
Revenue Anticipation Notes. Tax Anticipation Notes, Tax and Revenue Anticipation Notes, Bond Anticipation Notes. Short-term municipal borrowing of one year or less. See Municipal Notes.
Ratings
Rating agencies grade the creditworthiness of municipal bonds. Numbers go in, but there is no single formula by which the AAAs, AAs, As, and BBBs come out. Excellence can still be present in a lesser-rated bond, even if to a lesser degree. The upper four ratings are generally considered investment grade, adequate security for investors seeking the basic assuredness of interest and safety of principal that attracts one to municipals in the first place.
Rating Definitions (Moody’s)
Aaa
Issuers or issues rated Aaa demonstrate the strongest creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Aa
Issuers or issues rated Aa demonstrate very strong creditworthiness relative to other US municipal or tax-exempt issuers or issues.
A
Issuers or issues rated A present above average creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Baa
Issuers or issues rated Baa represent average creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Ba
Issuers or issues rated Ba demonstrate below average creditworthiness relative to other US municipal or tax-exempt issuers or issues.
B
Issuers or issues rated B demonstrate weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Caa
Issuers or issues rated Caa demonstrate very weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
Ca
Issuers or issues rated Ca demonstrate extremely weak creditworthiness relative to other US municipal or tax-exempt issuers or issues.
C
Issuers or issues rated C demonstrate the weakest creditworthiness relative to other US municipal or tax-exempt issuers or issues.
NOTE: Moody’s appends numerical modifiers 1, 2, and 3 to each generic rating category from Aa through Caa. The modifier 1 indicates that the issuer or obligation ranks in the higher end of its general rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Source: Moody’s Investor Service, Global Credit Research
Real Rate of Return
The “take-home pay” from an investment after taxes and inflation. Tax-free municipal bonds at least eliminate income taxes from the equation.
Retail Market
Not the banks, not insurance companies, not mutual funds or big financial institutions, but you, the individual retail investor, are the mainstay of the municipal bond market. Individuals own 71 percent of the munis outstanding, either directly or indirectly through mutual funds.
Revenue Bond
These are bonds secured by tolls, rentals, mortgage payments, tuitions, fees, or charges to the user instead of taxes. Among the projects financed by revenue bonds are transportation systems, turnpikes, hospitals, public housing, stadiums, airports, colleges, water and sewer systems, solid waste and resource recovery systems—in fact any municipal enterprise that sustains itself by selling its service to the public.
Risk
The exposure to loss arising from market volatility, changing interest rates, headlines, legislative threats to tax exemption, changing fortunes of the issuer, and the unpredictable outcome of markets driven by psychology as well as fundamentals.
Round Lot
A round lot is a block of bonds with a face value of $25M, $100M, $500M, or more, depending where you shop.
Secondary Market
The resale market that comes into being when the initial purchasers of a new issue begin trading their bonds.
Securitization
The bundling and turning a pool of illiquid assets into marketable securities, whose shareholders then participate proportionately in the cash flows from, say, mortgages, car loans, credit card debt, even back taxes and derivatives, and the losses and gains therefrom.
Senior Lien
A bond with first dibs on revenues earmarked for debt service.
Serial Bond
To avoid having to pay off an entire issue in a lump sum in a single year, a municipality will often retire its debt in annual installments over the anticipated life of the project by issuing its bonds serially, so they mature in staggered years.
Settlement Date
You buy a bond today (trade date). Three days later is the settlement date, and your payment is due.
SIFMA
Stands for Securities Industry and Financial Markets Association, the trade organization of banks, brokers, dealers who underwrite and sell municipal, U.S. government, mortgage-backed, corporate, and federal agency bonds.
Sinker
A call feature—or the kitty into which the funds are set aside periodically—to redeem part or all of an issue before maturity, as revenue come in and are available to do so.
Spread
The difference between bid/ask, wholesale/retail—reflecting the markup or intended profit in a bond.
Tax Bracket
Under our government's progressive tax system, when income brackets increase, the tax rate in that bracket increases, from 15 percent to 25 percent … 33 percent … 35 percent. If a taxable investment bumps you into the next higher tax bracket, that’s the bracket to use in computing the tax savings from switch to tax-free municipal bonds.
Tax Deferred
As applied to a tax-deferred retirement account, this means no tax on gains, growth, or income are due right now. You will be taxed when you take your money out.
Tax Free
Careful how you use the word, because tax free applies solely to freedom from federal income tax and from state and local income taxes to residents of the state where the bond was issued. Estate taxes, capital gains taxes, the alternative minimum tax, and the Social Security tax computation (requiring retirees to include tax-free municipal bond interest in determining taxes due on Social Security benefits) all apply, even to tax-free municipal bonds.
Tax-Free-to-Taxable-Yield-Ratio
Always remember, a dollar from a tax-free municipal bond that’s yours to keep is worth more than a taxable dollar. The tax-free-to-taxable-yield expresses the muni yield as a percentage of any taxable alternative you care to compare to the muni.
Tax Reform Act of 1986
The law that largely governs the issuance of tax-free municipal bonds today. It prohibits the issuance of tax exempts for certain nongovernmental purposes outright. It allows certain other nongovernmental bonds to be issued subject to volume caps. It limits the types of bonds banks can buy and still take the deduction for their cost of carry. It limits how many times a bond can be refunded and still qualify for tax exemption. It requires municipal issuers to rebate to Uncle Sam positive arbitrage earned on bond proceeds temporarily invested in construction funds and debt reserve funds. It created the alternative minimum tax on certain private activity bonds.
Tax Swapping
You sell your depressed bonds. You buy someone else’s (not substantially identical, please). And in the exchange, you realize an actual loss to use against gains or income. You not only save money in taxes, but you wind up with bonds replacing yours.
T+3
This is a securities industry requirement that we pay you and you pay us within three days following a trade. (T stands for trade date; 3 stands for days.)
Taxable Equivalent
The amount that a bank or other taxable alternative would have to pay you before taxes so that after the taxes in your income bracket, the net at least equals the tax-free return of a municipal bond you are considering. In determining if tax exempts are suitable for you, the idea isn’t for the municipal bond to just match the take-home from a taxable alternative but to top it.
Taxable Municipal Bonds
The 1986 Tax Act that governs the issuance of tax-free municipal bonds today bans tax-free municipal bonds for certain purposes deemed nongovernmental. Issuers are perfectly free to issue them—but as taxable municipal bonds. The existence of municipal bonds that are taxable opens the market for munis to tax deferred retirement accounts and tax-exempt organizations, whose investments are already tax deferred or tax exempt and don’t particularly benefit from tax-free munis. Taxable munis are usually free of state and local taxes to residents of the state where issued.
Total Return
All cash flow from interest and dividends plus compounding of reinvestment plus any gains or minus any losses. Total return does not include commissions, getting in and getting out costs, and taxes.
Trade Date
It’s the date the transaction is executed. Use trade date, not settlement date, to determine whether a gain or loss is long term or short term.
Unit Investment Trust
A municipal bond U.I.T. is an unmanaged, closed-end portfolio of municipal bonds that have been assembled by an investment company to provide unit holders with a steady, tax-free return. Once the bonds have been packaged and all the units (representing undivided interests in the underlying trust) have been sold, trading bonds in and out of the portfolio ceases (other than to get rid of any bond that’s in trouble and distribute the proceeds to the unit holders).
When Issued
Even though the terms may be set, until the bonds have actually been delivered by the issuer to the underwriter, new issues are offered and confirmed conditionally like this: “when, as, and if issued?”
Yield Curve
It can be positive (the longer the maturity, the greater the return). It can be negative. It can be inverted. It can be humped. It’s a graph showing bond returns relative to maturities.
Yield to Maturity
The most important measure of how hard money is working in a bond. Clip those coupons right along. Cash in the bond itself at the end. And you—or your heirs—will receive the promised yield to maturity.
Yield to Call
It’s the same idea as yield to maturity, except that yield to call is calculated to the call date and call price (which is not always par, but sometimes a premium).
Zero Coupon Bond
Traditional municipal bonds pay out interest right along. Zero coupon bonds pay out nothing right along. Zero. Goose egg. Zeroes are always issued below face value. Instead of paying out interest in the form of current income to be spent and frittered away, the interest is added to the pot and earns interest. Then that tax-free interest earns even more tax-free interest, building and rebuilding on itself right up to the day of maturity. Down the road, you wind up with a big lump sum. Tax free.