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Municipal Bonds

Risks and Creditworthiness

Risks to Consider When Building A Bond Portfolio

Any fixed income portfolio should be structured to balance "reward" - after-tax yield - against certain risks and constraints that the investor might face.

  • Market risk - the risk that the market value of the bonds in the portfolio might rise or fall, principally due to changes in prevailing interest rates. All other things being equal, a longer maturity bond is more volatile (i.e., is more likely to change in price) than a shorter maturity bond, for a given change in interest rates. In a given maturity, a discount bond is more volatile than a current coupon bond, which is more volatile than a premium bond.
  • Credit risk - the risk that the issuer might be unable to pay interest and/or principal on a timely basis. One type of risk is "downgrade risk" - the risk that the market value of a bond might erode, due to a reduction in the perceived credit strength of the issuer.
  • Reinvestment risk - the risk that an investor's overall portfolio yield might decline as principal and/or coupon payments are invested in a lower interest-rate environment. The risk is that when a bond is redeemed, the proceeds can be re-invested only in bonds that yield less than the original bond. This reduces the investor's expected rate of return on their investment. Reinvestment risk is very high on short-term instruments and is essentially non-existent on long-term, non-callable zeros. Other bonds fall between these two extremes.

Municipal Ratings

Although municipal bonds are considered to be safe investments, not every municipal bond has the same degree of safety. Furthermore, economic or political conditions in different states or counties can vary. That's why it's important to know the issuer's creditworthiness before you purchase a bond.

Presently, three nationally recognized companies, Moody's Investors Service (Moody's), Standard & Poor's Corporation (S & P), and Fitch Investors Service (Fitch), provide credit analysis of and ratings on municipal bonds. These ratings are intended to reflect bond quality and to give you a benchmark on a particular issue's creditworthiness.

The following is a summary of the Moody's, Standard & Poor's and Fitch categories:*

Description Moody's S&P's Fitch
Prime Grade Aaa AAA AAA
Excellent Grade Aa AA AA
High Grade A A A
Investment Grade Baa BBB BBB
Speculative Grade Ba BB BB
Low Grade B B B
Highly Speculative Caa CCC CCC

Moody's, Standard & Poor's and Fitch will sometimes indicate a slightly stronger or weaker position by using an additional symbol such as A1, A+ or A-.

*Please note: not all bonds or notes are rated; the lack of rating is not necessarily indicative of a negative credit rating.

Our Firm, its affiliates, and its employees are not in the business of providing tax or legal advice. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the "promotion or marketing" of the transaction(s) or matters(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.

For more information, please contact your Financial Advisor.

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