One of the ways they can achieve this cash injection is to raise the money by issuing bonds to a public market. In its simplest form, a bond is a loan for which the lender receives an agreed number of interest payments and in return, the issuer receives the capital that they need in order to finance their project. Here is a quick example to show how this works:

Bond Issuer -> Public Market -> Agree Terms -> Issuer Receives Funding -> Lender Receives Agreed Interest Payments.

The interest rate of a bond is quite often known as the coupon. The issuer not only has to honour the coupon, but also what is known as the maturity date which is when the issuer has to repay the investment (face value) back to the lender.

Here is another example for you to chew over:

You purchase a bond with the face value (investment amount) of $5,000, a coupon (interest rate) of 10%, and a maturity (repayment period) of 10 years.

Now if you do the math, this will mean you will receive $400 of interest for the next 10 years. After those ten years, you will then get your $5,000 back.

So you will have allotted $4,000 in interest over 10 years, plus the original $5,000 that you started with - not bad eh?

So now that you have an understanding of what bonds are, we can look more closely at their specific features.

First of all, bonds are debt they are not equity as like you get when you invest in stocks. When purchasing stocks you naturally become an owner of that corporation, with that come voting rights and a claim to future profits. When purchasing bonds however, as it is a debt, you become a creditor to the corporation or government that is issuing the bond. You also, as a bond holder, have a higher claim on the assets of the corporation/government in the case of bankruptcy. The advantage is that you have a lower risk but with that comes a lower return.

Finally, bond holders do not get a share of future profits as you do if you are a shareholder; you are only applicable for the original investment and the agreed interest repayment.

The key feature of a private purpose bond is that they are solely used to help finance private investments and amenities. Comparatively, a public purpose bond is exclusively for investments that benefit the public, i.e. public facilities or projects that benefit a sizeable community.

The reason why The Tax Reform of 1986 led to the separation of municipal bonds into two types was for a change in the taxation regulations. The taxation regulations are currently quite clear and state that: Private Purpose Bonds are applicable for taxation unless exempted (which is rare). Public Purpose Bonds are exempt from federal taxation.

The reason why these types of bonds are so popular with investors who have high incomes is because of their extremely favourable tax implications - they are exempt from federal taxes and in most cases state taxes too.

A word on the security attributes of a municipal bond fund - although they are backed by the government and are considered low risk rating, municipalities have in the past declared bankruptcy and avoided payouts altogether. So although they are generally low risk, investors should be aware that there are ways that you could lose out should something inadvertently go wrong.

Typically speaking, mortgage backed bonds offer exclusive protection that is rarely offered by other similar bonds. They offer the investor a massive amount of collateral in the form of protection as the asset could potentially be sold off to cover any debt that is owed. However, with this extremely good rate of protection comes the major drawback, these sorts of bonds have fairly low rates of yield, especially when compared to the more traditional corporate bonds and private bonds that are only backed by the corporation’s or municipality’s promise and real time ability to return payments.

A mortgage revenue bond is where the investment is in part subsidised by the government or authoritative entity that supports a certain demographic of low income earners to allow them to make home purchases. This type of bond was most popular in the late 80’s and early turn of this decade when borrowers were faced with an inability to purchase houses due to the depressive state of the US economy.

Simply put, a revenue bond is issued by a locality to financially support a specific public works project. The revenues that this public works project makes are then used to further support the projects existence. Revenue bonds are considered by many to be the second most secure type of municipal bond and are sometimes referred to as municipal revenue bond.

In essence, this is a type of municipal bond that is repaid by taxes collected from those who are appreciating (hopefully) the development or service that the project was funded for. An assessment bond is also sometimes referred to as a special purpose bond since the projects that they often fund are for the good of the community. An example; A local community sees their local facilities improved and a recreation facility produced. This not only increases the value of their homes as their neighbourhood sees a rise in value, it benefits them as individuals. However, with increased value come increased taxes, which of course are used to fund the project in the first place.

Taxable municipal bonds most commonly pay a higher rate of interest than other bonds, however with protection from early redemption and some exemption from state and/or local taxes with which the bonds are issued, it evens itself out. States will usually always use their allotted quantity/value of tax-exempt bonds and therefore issue taxable bonds which are most commonly used to finance private development. Taxable municipal bonds are always issued as private purpose bonds when financing projects such as sports entertainment facilities.

The general obligation refers to a pledge which is a set of conditions that state how a local or national government can issue or repay general obligation debt, including its securities. More often than not – as already mentioned – the use of land or property taxes and levying these in order to satisfy the borrowing of the debt requirements. Understandably those who own property are reluctant to lose their property because of unpaid taxes therefore the may consider using a credit agency to make a general obligation pledge for strong credit quality and assign a investment grade rating. This basically means that if property owners are late or miss their property tax payments their tax rate increases and the owner will indefinitely have to pay a higher rate the following year.

It is important to note that state laws determine the conditions of which a local government can issue general obligation debt and these have two forms;

• Limited tax general obligation pledge – Local government to levy property tax to meet debt obligations. It’s limited because the government can choose only a section of the tax that it decides to levy.
• Unlimited tax general obligation pledge – Identical to the limited but the government has a free reign to levy any tax rate they feel is necessary.

Corporate bonds more often than not pay higher rates of interest than other bonds such as municipal bonds as they tend to be a lot riskier. The reason being is that the investor is backing an individual or group of corporations, rather than a government or state approved project or organisation.

Corporate bond yield has quite a wide spectrum due to the many financial issuers that can be involved. A large, successful corporation may have bonds with a high investment grade value and rating, perhaps AA. However, with that rating comes a relatively low yield but a considerably lower risk of default. Comparatively speaking, high yield corporate bonds that are most commonly found in start-ups carry a higher risk but a greater value of reward.

There are three most common types of repayment source for municipal bonds, these are;

• General Obligation Bonds – These are well known for their security and low interest rates, the agreement is to repay in full the credit given by the issuer.
• Revenue Bonds – These are most common in active, working projects and investments as the agreement is to repay based of a channel of past, present and future incomes. An example would be a share of the income a power plant may generate.
• Assessment Bonds – These involve the repayment based on taxes, usually land taxes or property taxes located within the domicile of the issuer.

There are a number of other types of municipal bond repayment sources but the above three are the most common.

Depending on the value or importance of the municipal bond, you will quite often see external or third parties involved in reviewing and guaranteeing a repayment source or agreement. Typically the agreement is reviewed and then rated by the external agency, both sides of the municipal bond ie; investment holder/issuer will receive a copy of the review and the assigned bond rating.

In the United States of America there are three rating agencies most commonly used, these are; Fitch, Moody’s and Standard & Poor’s.