Municipal Bonds

Municipal Bonds:

Municipal bonds or “Muni’s” as they are sometimes called, are bonds issued by states, counties, cities, or other municipalities.  They are rated by bond rating companies such as Standard and Poor’s and Moody’s just like corporate bonds.  Unless the government changes things (which in this macroeconomic environment is always possible) municipal bonds are free of federal taxes. 

They are subject to state, county, city, and other local taxes under certain circumstances.  For example; if you live in New York City and invest in New York City municipal bonds then you are likely to be subject to New York, state, county, and city taxes on the income your bonds produce.  If you live in any other state other than New York then you are not subject to those taxes.   In short, if you want to buy muni’s you usually should not buy the ones from cities in the state in which you reside. 

They do not pay as much interest as corporate bonds; usually they pay in the 1% to 3% range with between 1% and 2% being most common.  By being tax free you could think of it as a corporate bond that you pay taxes on that pays about 4% is about the same as a municipal bond that you don’t pay taxes on that pays 2%.  Your individual income and tax situation will dictate your actual results this is simply a general rule of thumb or guideline. 

Are they safe?  If you buy the highest rated ones, they are mostly safe, remembering that nothing is absolutely safe.  There are two threats to municipal bonds.  First the issuing municipality could declare bankruptcy in which case you lose all the money you invested in your bond.  It has happened.  Orange County California went bankrupt several years back after their local elected officials invested their funds in very speculative investments that tanked causing the county to go broke and all their bond holders to lose their money. Second, should the federal government change the rules making municipal bonds no longer tax free, then most of the holders of municipal bonds would sell them and take their money to invest elsewhere.  As the price of all investments is controlled by the law of supply and demand, having most holders sell at about the same time would cause the value of the bonds to plummet and huge losses could be realized.  No one knows if the federal government will ever do this but they are discussing it from time to time. 

In general,  municipal bonds are held by investors who have a substantial amount of money and they are looking more for a tax shelter for their investment than to make a ton of loot.  Just think if you make 2 million dollars a year why would you want to risk it?  Rich folks often invest in government and municipal bonds to keep their money safe and in the case of the muni’s,  to avoid paying taxes.  I don’t think that muni’s are a good investment for the small investor, but in the end, it is up to you to do what you wish with your money.

Remember that on average inflation runs around 3% a year so if you are only making between 1% and 2% on your investment you are losing money to inflation every year.  Which is ok if you have millions of dollars but it is not so good if you just have a few hundred thousand or less to last you the rest of your life.  As always contact a certified investment planner who sells nothing but advice before investing.   Remember my writings are simply to educate and not to advise you what to invest in. 

Other than what is stated above, municipal bonds work pretty much like corporate bonds in that they pay out usually every quarter, have a maturity date, are rated by the bond rating services, and some may be callable. As in the case of all types of bonds, they may pay quarterly, semi-annually, or annually.  The main difference is they are federal tax free, pay a lower interest rate, and are backed by local governments and not by companies or the federal government.

Copyright 2012, Greg High, all rights reserved. 

Corporate Bonds

Corporate bonds:

  Corporate bonds are very similar to preferred stocks in that they pay interest to the holder usually on a quarterly basis.  When you buy common stock you actually are buying a piece of that company but when you buy a bond you are actually loaning that company money.  It’s just like when you go to your local bank and borrow money.  In this case you are the bank and you are loaning money to a corporation and in return they will pay you interest payments.  It is very similar to you paying your bank payments on a loan.

 Bonds are rated and there are several rating systems.  The two most famous of the bond rating systems are S&P and Moody’s.    While the rating systems are slightly different, in general a rating of AAA would be the best AAB not quite as good and BBB is the lowest rating that is considered to be an investment grade bond. 

CCC and lower are junk bonds and while they pay very high interest rates, they are not safe.  Why?  The reason is that if the company was stable they could borrow money at a lower rate.  Issuing bonds at a high interest rate is done only as a last resort in most cases and there is a very high danger that companies issuing high yield bonds (also known as junk bonds) will go bankrupt and your bond will be worthless.  If you want to invest in junk bonds only do it in a junk bond fund that way your risk is spread out over thousands of bonds not just one or two and if a few of them go bankrupt you don’t lose everything as you would if you actually bought individual junk bonds. 

Most corporate bonds are not rated AAA, that rating is usually reserved for government backed bonds which corporate bonds are not.  If you chose bonds that are rated BBB and higher then you should be ok but as always there are no guarantees.  Bonds pay an interest rate currently somewhere between 3 and 7 percent with 4-5 being about the norm. 

Just like the preferred stock, as the price of the bond goes up the yield goes down and conversely as the price of the bond goes down the yield goes up.  However if you buy the bonds new and they pay 5% then your yield will always be 5% and it will never change.  Only when the bonds are resold at a higher or lower rate will the yield change. 

The face value of most bonds is $1000.00 when you buy them new.   Oddly enough when you see them listed in the newspaper the new bond would be listed as 100, but it means 1000.  That is a traditional holdover from an earlier time but you should be aware of that factor. 

Most bonds have a maturity date such as if you buy an XYZ company bond that matures in 2025, then in 2025 no matter what the bond has been selling for, it will be redeemed for the $1000.00 face value that you paid for it all those many long years ago.  Bonds can have “call provisions” which simply means if the economy and interest rates change the company has the right to give you your $1000.00 back in full along with any earned interest.  They would do this if interest rates went down and would call in 7% bonds to reissue 5% bonds, for example, as a cost savings for the company. 

There are two types of bonds a regular bond and a debenture.  The regular bond is backed by the assets of the company, so if they go bankrupt they must sell off their assets (forklifts, buildings, furniture, equipment) and give the bond holders some of that money (if there is any left after paying the creditors).  With a debenture you are only going with the full faith and credit of a company’s good name with no assets backing up the bond. 

One probably should not just buy one or two bonds.  If you hold one or two bonds then after one year you would have 50-100 dollars for all your trouble.  That’s not even a good night out on the town anymore.  When considering bond purchases buy 5 or 10 if you can or more and as always, diversify your investments by buying for example, 10 of Company A, 10 of Company B, 10 of Company C, and so on so that your money is invested at least in 3 or 4 different companies and use the bond rating system to help you select the right bonds for you. 

Copyright 2012 , Greg High , all rights reserved.

What is a preferred stock?

Preferred stocks are more like bonds than stocks.  In general, the new price for a share of preferred stock is $25.00 per share.  There are exceptions to this but let us stay with the most common example.  If you buy the preferred shares from the broker at its new issue point then you would pay $25.00 a share.  Every trade after that time is on the secondary market and the price per share is subject to the laws of supply and demand.  The more people that want the stock the higher the price is per share and if fewer people want to own the stock then the price generally goes down.

Every share of preferred stock will have a yield.  For example, one share of XYZ preferred stock sells for $25.00 a share at its new issue and has a yield of  5.0% payable quarterly.  So the yield upon the first day of issue is 5% and you will get a payment of $1.25 per share per year and you will get that payment quarterly at a rate of $0.3125 per share.  (0.3125 times 4 quarters = $1.25)  This is either sent to you in the form of a check or more likely it will be deposited in your brokerage account. 

Let us then say the price of the stock goes up to $27.00 a share after a few months time.  The yield will now show at 4.62 % yield and this applies only to those folks who pay $27.00 per share for the XYZ stock on the secondary market (the name for the stock market after the initial IPO is complete).  Worry not, because you only paid $25.00 a share your yield will never change, you will still get $1.25 per share per year and that will forever be a 5% yield for you.  It is ONLY the person who buys the stock at a different price than the issue price that will get a different yield than you did as the original owner of the shares.

So let’s look at the opposite scenario.  Suppose the price of the stock goes down and not up?  If the price of the stock is now 23.00 a share it will still pay $1.25 per share per year making your new yield 5.43%. 

To review you bought the issue new, then sold the stock to the second owner, who later sold the stock to the third owner.  They all make $1.25 per share per year in interest but the yield changes whenever the price of the stock changes:

You = 1 share at $25.00 per share paying you $1.25 per year interest = 5% yield
2nd owner 1 share at $27.00 per share paying them $1.25 per year interest = 4.62% yield
3rd owner 1 share at $24.00 per share paying them $1.25 per year interest = 5.43% yield

Prices of preferred stocks do not change much but they do go up and down a little most every day.  Also when the stock goes ex-dividend (the date that you must own the stock to get the dividend for that quarter) the price of the stock goes down just a little for a while.  If you buy the stock the day after it goes ex-dividend, then you do not get the interest payment for that quarter (usually just a few days after the ex dividend date). 

Note that preferred stocks pay interest not dividends.  Dividends are paid on some common stocks but not on preferred stocks.  They do use the term ex-dividend for the date described above and that can be confusing but that is what they call it. 

In the overall scope of safety, preferred stocks are safer and less volatile than common stocks and if the company you invested in goes bankrupt the preferred stock holders may get some of their money back before any of the common stock holders are paid.  It is possible for any common stock or preferred stock to go all the way to zero which means you lose all your money.  Nothing is completely safe but FDIC insured CD's or deposits and Government Bonds are generally among the safest investments although they pay little or no interest these days (2012-2013).
Copyright 2012 All rights reserved,  Gregory L. High

What is a common stock?

This information is for people who know little or nothing about stocks and bonds. It is basic education on what stocks and bonds are and not for people who already know how to trade stocks and bonds. If you want to know what stocks to buy or sell look elsewhere. It is my intent to cover the academic basics of stock and bond investing in this blog. I am not a financial planner and will not give advice on what to invest in or what not to invest in. I have Masters degrees in Management, Business, and Human Resource Development and have taught university level (grad and undergrad) courses in all these subjects for the last 11 years. In my finance courses I teach the basics about stocks and bonds, investing, and retirement planning. This is simply basic academic information about what stocks and bonds are, what a 401K is, what an IRA is and other financial information that anyone might need to know. The examples are very simplified intended to educate not to include every detail, real life is always different than a simple example can show.


Today I want to discuss common stock. What is a common stock? When a company grows to the point where they need additional money to continue operations they may issue common stock to raise needed funds. Let us use a simplified example to explain this. You have a computer manufacturing company you run out of your garage. You become successful and get orders for thousands of units. You cannot build thousands of units in your garage so you go to an investment bank and work with them to take your business public. Then you will do an initial public offering or IPO which means you work with the banker to determine a value for your company and then issue shares of common stock that can be bought by the public. Let us say you issue 10,000,000 shares at a cost of $10.00 a share. You and your company retain 51% of the stock so that you will maintain control of your company. (Each share of stock is a voting share and you want 51% of the votes to maintain control). Then 30% of your stock is offered for sale to the public or 3,000,000 shares (3 mil X 10$ a share =30 Million dollars). Every person that buys a share of your stock is now a part owner of your company! Only when you buy common stock do you become a part owner of a company. You have retained 1,900,000 shares of stock that you may choose to sell later if your company needs to raise more money.


(5,100,000 shares belong to you, 1,900,000 shares belong to your company and can be sold later, and 3,000,000 shares now are in the hands of the public). Now you have the funds to build a small manufacturing facility and hire some workers who will build and ship your computers to your customers.


A company only makes money on the initial public offering. Every time a share of your stock is bought or sold after the IPO, only the buyers and sellers make or lose money on the stock. That is called the secondary market. The secondary market is what you see and hear discussed on the news and on financial shows such as CNBC, Mad Money, etc.


After the IPO is complete you now are running a public company and you are now responsible for producing the balance sheet, cash flow statement, and income statement every quarter and for publishing an annual report to your stockholders. You are now under the laws and rules of the Securities and Exchange Commission and you must follow these rules or risk fines and jail time. If you run the company well it is likely that the price of the stock will rise. If your company does not make money the price of the stock will be expected to fall. To see whether a stock is making or losing money one place to look is at the EPS or earnings per share which is available at many places on the Internet and in your quarterly and annual reports. In general the more money your company makes per share the better you are doing and the happier your stockholders will be. Negative numbers are never good and would most likely cause holders of the stock to consider selling their shares.


What makes the price of a common stock go up or down?


It is simply the law of supply and demand. If there are more buyers that sellers then the price will go up. If there are more sellers than buyers the price will go down. For example, if your new stock is still selling at $10.00 a share in the secondary market (the stock market) and I want to sell 1,000 shares of your stock, I may offer 1,000 shares for sale at $10.50 a share, if someone buys it at that price, the new price of the stock is $10.50 a share. That price is only good until the next trade which may be very different. If however, I offer the stock at $10.50 a share and no one buys it, I might then lower the price to $10.25, if still no takers I might try $10.00 and then $9.75, and lower until I hit a price where someone thinks the stock is a good buy at that price and buys my 1,000 shares. If I end up selling at $9.50 then the price of the stock is now $9.50 a share at least until the next trade. The more buyers for a stock means the supply of stock for sale is used up quickly and then they have to offer more to get someone to sell some of the stock to them, if no one wants to buy the stock the price must go lower until a buyer is found who is willing to buy the stock at that price. It is as simple as that, if there are more buyers than sellers the price of a stock goes up, if more sellers than buyers then the price of a stock goes down.


What makes people want to pay more or less for a stock? That may depend on news of a big new contract which might make more people want to buy the stock betting that they will make money when the stock goes up or if news of a law suit comes out that might mean the company might have to pay out a large sum of money then that may have the potential to drive the price of the stock down as investors sell to avoid possible losses should the law suit go against the company. There is a lot of psychology to the market and to buying and selling. As of this writing the market is being moved up and down based on employment reports (if good the market goes up which means people start buying stocks and if bad the market goes down as people sell their stocks.) Another market mover today is any positive or negative news coming out of Europe, if it looks like they are going to save Greece from default the market goes up, if it looks like they won't it goes down. If it looks like the countries in the EU are going to fund their banks if they start to fail the market goes up if not it goes down and so on.


In addition, there are stock analysts and rating agencies that rate stocks (and bonds) and a change in their ratings may influence stock holders to buy or sell a particular stock.





Dividend and Growth Stocks: Some stocks pay a dividend which means you get a check (or deposit to your account) every 3 months for 1/4 of that years dividend. Let us say our sample stock pays $0.40 per year per share of stock you hold. In that case every 3 months you would earn 10 cents for each share of stock you hold. If you bought 100 shares you would receive (10 cents X 100 = $10.00) every three months. Initially your yield for this stock would be 4% (40 cents is 4% of $10.00). The yield changes as the price of the stock goes up or down but we will cover yield in a future post.





Other stocks are called growth stocks and they do not pay a dividend as all profits are plowed back into the company to enhance the growth of the company. In this case the stock holder makes money by the eventual price of the stock going up and the money is made when the stock holder sells at a higher price than the price they bought the stock for.





Stocks are simply a way for companies to sell part of their company to the public in order to raise money to make more product, build more facilities, expand, hire more people, or market their product more effectively.





This concludes our basic lesson on what is a common stock. In future posts we will cover corporate bonds, preferred stocks, municipal bonds, government bonds, 401K's IRA's, Roth IRA's and other general topics relating to personal finance. I will never recommend a stock or bond or course of action for you to take, I advise everyone to get a good certified financial planner who sells nothing but financial information for all your personal investment planning. This blog is for educational purposes only.


Copyright 2011 all rights reserved - Greg High