The Fundamentals of Municipal Bonds

Praise for the Classic Guide to the Bond Market

"This is simply the most comprehensive, useful look-it-up book onmunicipal bonds I've ever read (said with all due respect to TheABC of Municipal Bonds my dad wrote in 1937 when I was nine). ReadFundamentals cover to cover. I'm keeping mine in my briefcase,under my arm, at my fingertips. No accountant, financial advisor,attorney, new bond salesman, reporter, regulator, test-writer,cautious, suspicious first-time investor in municipal bonds, ordinner guest is ever going to catch me again with a question aboutmunicipal bonds I can't answer."-Jim Lebenthal, Chairman, Lebenthal& Co.

"Judy Wesalo Temel gives us the Rosetta stone of the municipal bondmarket, the key to unraveling the many mysteries of 'muni's.' Herbook, a fresh take on the old standard Fundamentals of MunicipalBonds, updates chapter and verse on everything from investing tounderwriting, from over-the-counter to over-the-Internet. The styleis clean, crisp, and as simple as this complex subject can be. Areyou a novice who wonders how to invest in bonds? She lays out thebasics. Examples are easy to follow-even the mathematical ones thatare critical to explaining how municipal bonds work. At the sametime, there is plenty of meat for the pros. Whether you need tostart from square one and learn all about municipal bonds and howthey work, or need a ready reference for specific technicalquestions you run across as a market professional, this book is foryou."-Kathleen Hays, Economics Editor, Credit Markets Reporter, and"Bond Belle" CNBC

"This is a must-read for every scholar, banker, and public officialconcerned with local government finance in the United States. JudyWesalo Temel has done the impossible: she has clearly andinsightfully explained how we finance the development of thenation's vital public infrastructure. This is an important book,one that will be required reading for professionals responsible forplanning, designing, and evaluating publicly financed projects-thehealth care, transportation, and educational facilities that allcitizens rely upon. The bond market is an essential element in thelife of local and state government, and this book makes itunderstandable to all Americans."-Mitchell Moss, Henry Hart RiceProfessor of Urban Planning and Director, Taub Urban ResearchCenter, Robert F. Wagner Graduate School of Public Service, NewYork University

Preface ix

Acknowledgments xi

Writer’s Acknowledgments xiii

Chapter 1 Overview of the Municipal Bond Market 1

Introduction 1

The Issuers 3

Municipal Bond Dealers 6

Bond Brokers 9

The Lawyers 10

Financial Advisors, Specialists, and Other Consultants 11

The Rating Agencies 12

The Credit Enhancers 12

The Trustees and Paying Agents 15

The Investors 16

Information and Technology 17

The Regulators 17

Other Participants 20

Chapter 2 The Basics of Municipal Securities 21

Description of Municipal Securities 21

Yield and Price 23

Types of Yields 25

Tax Exemption of Municipal Bonds 27

Types of Municipal Bonds 33

Short-Term Securities 33

Other Characteristics of Municipal Bonds 39

Chapter 3 The Issuers 49

Introduction 49

Authorities and Special Districts 50

The Theory of Municipal Debt: Pay-as-You-Use versus Pay-as-You-Go 51

The Uses of Municipal Debt 53

The Security for Municipal Bonds 55

The Financing Process 62

The Financing Documents 65

Assessing the Impact of the Debt 72

State and Local Government Accounting 78

Chapter 4 The Primary Market 82

Issuance Trends in the Primary Market 82

The Basics of Underwriting 85

Negotiated Underwriting 90

Competitive Underwriting 93

Orders and Procedures 100

Chapter 5 The Secondary Market 104

Introduction 104

The Over-the-Counter Market 104

E-Commerce, Information, and Technology 105

Selling Municipal Bonds 108

The Basics of Municipal Bond Trading 109

Municipal Bond Trading 110

How a Trade Is Done 113

Municipal Futures 116

Providers of Data in the Municipal Market 119

Market Statistics and Indexes 119

MSRB Record-Keeping Rules 124

Chapter 6 Investing in Bonds 126

Introduction 126

The Basic Principles of Investing in Bonds 126

Measures of Yield and Return 130

Yield to Maturity and Price 131

Investment Objectives 133

Risk Factors 135

Investor Strategies 136

Taxation of Municipal Bonds 138

Other Investment Factors 147

Investor Categories 149

Chapter 7 Credit Analysis 159

Introduction 159

The Rating Agencies 161

The Rating Process 171

General Obligation Bonds 172

Revenue Bonds 181

Other Factors Affecting Credit 190

Chapter 8 Understanding Interest Rates 193

Introduction 193

Determinants of the Overall Level of Interest Rates 193

Term Structure of Interest Rates 198

Municipal Bond Rates 202

Chapter 9 Regulatory and Disclosure Requirements 206

Introduction 206

The Basis of Federal Tax Exemption 207

History of Federal Tax Legislation Affecting Municipal Securities 209

The Current Statutory Exemption 210

Application of Federal Securities Laws to Municipal Securities 214

The Municipal Securities Rulemaking Board 219

Chapter 10 Financial Products 224

Introduction 224

Interest Rate Swaps 224

Interest Rate Caps, Floors, and Collars 227

Managing the Asset Side 228

Appendix A 230

Appendix B 238

Glossary 239

Bibliography 258

Index 263

About the Writer 275

About the author

THE BOND MARKET ASSOCIATION is the trade association representing securities firms and banks that underwrite, trade, and sell debt securities, both domestically and internationally. The Bond Market Association actively speaks for the bond industry, advocating its position and representing its interests in Washington, D.C., New York, Europe, and Asia. The Association’s membership collectively accounted for over 97% of the nation’s bond underwriting activity in 1999. For more information about the Association, visit www.bondmarkets.com.

About the writer

JUDY WESALO TEMEL has spent her career in the municipal bond business, on both the broker-dealer and issuer sides. She worked for seventeen years at Goldman, Sachs & Co., following employment at Lehman Brothers, and the Office of the Comptroller of the City of New York. She serves on the boards of several large not-for-profit agencies and speaks and writes widely about many aspects of the business. Temel is a graduate of Cornell University and holds an MPA from New York University.

This informative volume is an update of the long-heralded classic text on the municipal securities market. Written by Judy Wesalo Temel for The Bond Market Association—the leading trade association that represents the players in this market and whose members underwrite 90% of all municipal bonds—this newly revised Fifth Edition deals comprehensively with the many recent developments in the municipal securities market. It provides a basic understanding of the market for a wide range of readers, including experienced professionals, public officials, private investors, academicians, and students. Major changes covered here include:

• The explosive growth of technology and e-commerce
• New disclosure regulations
• Size and composition of the business
• Size and composition of investors
• The use of credit enhancement
• The use of financial products

Along with the addition of an extensive new glossary of municipal terminology and a bibliography, The Fundamentals of Municipal Bonds provides detailed explanations and a variety of relevant examples to illuminate crucial areas such as:

• The Basics of Municipal Securities
• The Issuers
• The Primary and Secondary Markets
• Investing in Bonds
• Credit Analysis and Understanding Interest Rates
• Disclosure and Regulatory Requirements
• Financial Products

Illustrated with numerous tables, charts, and mathematical formulas, this indispensable volume serves as a guide, reference work, and portal to the municipal securities industry. No investor or student of the market can afford to be without this Fifth Edition.