Municipal Bond Funds and Bond Duration

Municipal bond funds are funds that are made up of municipal bonds bundled together. Municipal bonds are bonds issued by city and local governments, as well as by city and local government agencies. The bonds are used to raise money without raising taxes or adding new ones. The investors buy bonds and receive interest payments until they mature, at which point they get their initial payments back. Municipal bond funds combine the interest payments and distributed them among investors. While municipal bond funds have lower yields than other bond funds, they are more secure and the yields are tax-free.

Understanding Municipal Bonds

City, county and state governments get most of their funding from taxes. Therefore, if they want more funding, they must logically raise taxes. However, this tends to be unpopular with voters, so municipal governments tend to avoid that option unless they have no other choice.

This is where the municipal bonds come in. The municipal bonds allow city and local governments to borrow money from taxpayers without raising taxes. When an investor buys a bond, he or she will receive a document that certifies that he or she will get the money back after a certain fixed period of time. That period of time is known as the rate of maturity. Until the bond matures, the investor receives interest payments. The interest rates are fixed until the bond matures. However, they are readjusted throughout the year based on the financial health of the municipal entities that issued the bonds. The interest rates are inversely proportional to the municipal agency's financial health. This means that the value of the interest payments hinges on when the investors bought the bonds.

The interest payments are not subject to federal taxes. If the investors live in the same state as the municipal entity that issued them, the interest payments aren't subject to state taxes, either.

Understanding Municipal Bond Funds

The municipal bond funds are funds that are made up of municipal bonds with the same rate of maturity. The municipal bond funds allow investors to pull their money together and buy bonds that they may not necessarily be able to afford on their own. An experienced financial investor pulls those bonds together and becomes the fund's financial manager. It is his or her job to manage all the fund-related financial transactions and do his or her best to ensure that the investors get their money's worth. This allows less experienced investors to enter the municipal bonds market and earn profits without having to learn its intricacies.

Municipal Bond Funds and Effects of Duration

When it comes to the long-term value of the bonds, the rate of maturity matters a great deal. This is due to the number of factors.

First and foremost, the longer the municipal bonds mature, the more likely it will be that the interest rates will rise. While this is good for investors who bought the municipal bonds at that point, the investors who already had the bonds wind up losing money.

Second, the longer it takes for the municipal bonds to mature, the more likely it is that the municipality's finances would get so bad it would not be able to pay back the bonds. Traditionally, the municipal bond funds were considered safer than funds that included privately financed bonds. That's because the cities were far less likely to go bankrupt than individuals and corporations. However, this conventional wisdom came under question as the recession left many cities short on revenue and struggling to pay the bills. As the result, many experienced investors prefer to invest in municipal bond funds with shorter rates of maturity.

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