Municipal bonds: a contingent claims perspective |
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| Affiliation: | 1. University of Bath, United Kingdom;2. University of Lethbridge, Canada;3. La Trobe University, Australia;1. Centre for Economics and Financial Econometrics, Deakin Business School, Deakin University, Australian;2. Finance and Financial Control Research Group, Department of Business and Economics, Passau University, Germany;1. U.S. Securities and Exchange Commission, 44 Montgomery Street 2800, San Francisco, CA 94104, United States;2. Texas Christian University, Neeley School of Business, Box 298530, Fort Worth, TX 76129, United States;1. Fiscal Affairs Department / Tax Policy Division, IMF, 700 19th Street, NW, Washington, D.C. 20431, USA;2. OFS, University of Oslo, Norway;3. CESifo, Munich, Germany |
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| Abstract: | The purpose of this paper is to provide an overview of the municipal bond market with an emphasis on the numerous embedded contingent claims. Embedded contingent claims include the standard call features, sinking funds, the advance refunding option, the synthetic advance refunding option, the credit risk option (default risk), marketability, and the numerous tax-related events. Municipal bond investors must carefully assess the relative value of these contingent claims before investing in municipal bonds. Also, due to unique risk premiums within the municipal bond market, it is important to carefully structure the municipal bond holdings, paying particular attention to duration, within the context of an overall financial plan. There appears to be a benefit to lengthening the duration of the municipal bond portion of the portfolio. |
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