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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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Learning from History

So what exactly did we learn from the high yield market’s murky past? The first lesson is that we really should stop treating the municipal market as if it were a single, monolithic entity. As the historical default record shows (see Chapter 4), there are actually two distinct market segments. On the one hand, you have what most investors would think of as the muni market, comprised of the general obligation and essential service revenue bonds that finance the traditional functions of state and local governments and their agencies. This segment has historically benefited from extremely low cumulative default and bankruptcy rates. As seen in Chapter 9, even if an essential service municipal entity still ends up filing for bankruptcy, its bondholders still enjoy very strong legal protection in most states and, except for a few missed coupon payments, the prospect for full or near-full recovery are usually quite good.

Existing alongside that traditional tax-exempt market is the so-called high yield muni sector, perceived by many as a demimonde of shady deals and dubious risk-taking, best left to institutional investors with large investment pools who can properly “diversify” risk. While this perception has been correct to a certain extent, as evidenced by the relatively high incidence of default in unrated issues (Chapter 4), high yield munis have been shown to display attractive tax-adjusted risk-return characteristics, as long as credit exposure is actively ...

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