General Price Analysis of Municipal Bonds

Liquidity

Municipal bond prices, in general, tend to fluctuate in the market place more often than either government or corporate bonds. The market for municipal bonds albeit large in size, is extremely fragmented with only few regular market makers. The market makers are dealers who stand ready to buy and sell bonds at the going market rate. Because in general, there are less market makers for specific issues of municipal bonds, the price of these bonds tend to fluctuate more.

Interest Rate Risk

In general, fixed income investments have an inverse relationship with market interest rates. When market rates rise bond prices tend to decline. On the other hand, when market interest rates decline bond prices tend to rise. Long-term bonds are more susceptible to interest rate risk because as market rates rise investors are locked into lower fixed income rates which don’t reflect a higher interest rate environment in the marketplace. However, in a declining interest environment, long-term bonds become more attractive because they lock in higher coupon rates than on going market interest rates.

Credit Risk

Credit Risk is the risk that an investor will lose the principal invested as a result of an issuer’s default. Long-term fixed income investments have a greater credit risk because of future uncertainty. Government and municipal bonds have a better reputation than other fixed income investments because of historically lower default rates.

Coupon Risk

Coupon Risk is a risk that at the maturity of a bond an investor will be forced to reinvest principal at a lower rate than before. This occurs in an environment of declining interest rates. However, in a period of rising market rates an investor will benefit at maturity.

Maturity Risk

The longer a bond matures the greater its price volatility due to a change in market rates. Long-term maturities tend to exhibit higher price volatility than short-term maturities.

Municipal Bond Insurance

Municipalities can enhance the credit worthiness of their new and existing outstanding debt by buying insurance. Insurance policies, insure the interest and principal payments of a municipal debt when due. An insured bond is implied to carry the same rating quality as the insurance entity guaranteeing that debt, even if the municipality is shown as non-rated. Some rated municipal bonds carry two independent ratings: 1) an enhanced insured rating and 2) an underlying rating. Before investing in municipal bonds an investor needs to evaluate both ratings independently and put together. The following table lists the current industry credit ratings for insurance companies in the market place that offer insurance enhancement policies for municipal bonds.