Municipal Bond Terms

When investing in municipal bonds, there are a number of terms that you should know so that you can understand the investment that you are making. If at any point you find the terms confusing or you need help with your investment decisions, a financial advisor can help you. However, you can work well in conjunction with your financial advisor if you educate yourself as much as possible.

There are many terms that are associated with municipal bonds, but what you can do is learn some of the basics.

Tranches

Tranche is a term that you are going to hear often because it defines a certain class of bonds. Each tranche possesses a different degree of risk. A portfolio may be partitioned off to offer different types of investments. For instance, a portfolio may consist of domestic mortgage investments, while another partitioned section may include foreign mortgage investments.

And usually accompanying the term "tranches" is the term "CMO." This stands for collateralized mortgage obligation, which is simply a mortgage-backed security that creates pools of rates called "pass-through rates" that different classes of bondholders holding varying maturities (tranches) can receive repayment from.

In addition to just the word "tranche," you will most likely encounter the word "active tranche." This simply means that the CMO tranche is making regular payments to its investors, which is what you want. A companion tranche is also a CMO tranche that can stabilize a principal payment schedule for what is called a TAC tranche or a PAC tranche because of its ability to absorb a higher level of impact from the collateral prepayment variability.

A TAC tranche is a targeted amortization class tranche and uses an assumed prepayment rate to determine the fixed principal payment schedule. A PAC tranche is a planned amortization of a premium class tranche is similar to a TAC tranche in that it also uses prepayment assumptions.

There are many other terms regarding tranches than what you see here, but this gives you a rundown of some of the most basic that you will see.

Other Bond Terms

There are a number of other municipal bond terms that you should know. For instance, your accreted value is the money that your bond has accumulated and then be reinvested into your bond, thus increasing your return on your investment.

You also have your accrued interest, which is a very common term because it is the money that your bond makes. However, it is the money that you have not yet received in the form of payment.

When it comes to the tax on your bond, you have your ad valorem tax, which is tax that is based on the value of property. In the case of a bond, it is considered property.

If you invest in a discount bond, you are investing in a bond that is worth less than its face amount and, of course, the face value is what you initially paid to purchase the bond. There are, however, premium bonds, which are bonds that are valued higher than what was initially paid for it.

Lastly, the yield is the amount of money the bond has generated in the form of income. You can take the amount of interest that has been paid and divide it by the price of the bond. And if you yield to maturity, you should be paid the rate of return that was expected if you held the bond until its maturity date.

There are many terms that can be used when being applied to municipal bonds and hundreds more terms that define the world of investment. If confused, a financial advisor can help.

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