TAILIEUCHUNG - Municipal Bonds: Understanding Credit Risk

However, a major change in the relationship between the credit rating agencies and the . bond markets occurred in the 1930s. Bank regulators were eager to encourage banks to invest only in safe bonds. They issued a set of regulations that culminated in a 1936 decree that prohibited banks from investing in “speculative investment securities” as determined by “recognized rating manuals.” “Speculative” securities (which nowadays would be called “ junk bonds”) were below “investment grade.” Thus, banks were restricted to holding only bonds that were “investment grade”—in modern ratings, this would be equivalent to bonds that were rated BBB– or better on the Standard & Poor’s scale. With these. | INVESTOR BULLETIN Municipal Bonds Understanding Credit Risk The SEC s Office of Investor Education and Advocacy is issuing this Investor Bulletin to help educate investors about assessing credit risks they face when purchasing municipal bonds which may also be called notes or certificates of participation. Credit risk or default risk is the risk that interest and or principal on the securities will not be paid on time and in full. Investors need to know who is responsible for repayment of the securities and the financial condition of that entity to assess the credit risk and decide whether to purchase the securities. It is important to look beyond the short-hand label given to a municipal bond such as general obligation bond or revenue bond or the bond s credit rating. Investors should read the disclosure document known as the official statement which provides important details about the offering including the factors described below. What are Municipal Bonds Municipal bonds are debt securities issued by states cities counties and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools highways or sewer systems. By purchasing municipal bonds you are in effect lending money to the issuer in exchange for a promise of regular interest payments usually semi-annually and the return of the original investment or principal. The entity responsible for repaying the principal and interest on the bonds may be the issuer or an underlying borrower known as the obligor or obligated person. Obligors could be another governmental entity a for-profit firm or a non-profit entity. The date on which the principal is scheduled to be repaid known as the security s maturity date may be years in the future. Generally the interest on municipal bonds is exempt from federal income tax. The interest may also be exempt from state and local taxes if you reside in the state where the bond is issued or if issued by a . territory such

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