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Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income by Triet Nguyen

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What Is a High Yield Municipal Bond?

Let’s start with the traditional definition: A high yield municipal bond is a bond issued by a state or local governmental entity (including conduit entities created just for the purpose of issuing tax-exempt bonds), which is either nonrated or rated below investment grade (i.e., below BBB). The coupon income for these securities is generally tax-exempt, although it may also be taxable or subject to the alternative minimum tax (AMT) in the case of so-called private activity bonds. Because of their lower or nonexistent ratings, high yield municipals are priced with an additional yield premium to compensate investors for the perceived higher credit risk.

In some cases, the term municipal may actually be something of a misnomer: While traditional high-grade munis are issued to finance public-purpose projects such as schools, utilities, and the like, most high yield munis are actually issued to finance private-purpose projects. Because the tax code allows private projects access to tax-free financing to achieve such goals as economic development or pollution control, governmental entities sometimes act as merely a conduit to issue bonds on behalf of such projects. The municipal issuers have no obligation to repay the bonds, and the private obligors are the real credits securing debt service.

Away from the private-activity bonds, other tax-exempt entities such as acute care hospitals (rated A or below), nursing homes, and retirement facilities also ...

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