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Mortgage-backed and Municipal Zero-coupon Bonds
Mortgage-backed zero-coupon bonds
Ginny Mae, Fannie Mae and Freddie Mac offer mortgage-backed zero-coupon bonds that are entirely backed by issuers. However, due to pre-payment risks, investors could become aware that these zeros could be cancelled before the established maturity.
Ginny Mae, Fannie Mae and Freddie Mac offer mortgage-backed zero-coupon bonds that are entirely backed by issuers. However, due to pre-payment risks, investors could become aware that these zeros could be cancelled before the established maturity.
Municipal zero-coupon bonds
These securities are issued by local and state governments and are advantageous due to the accrued interest which are exempt of federal taxes and usually of state taxes (if issued in the state of the taxpayer).
Municipal zero-coupon bonds come in two kinds: the general obligation zero-coupon bonds issued by the state, and the project zero-coupon bonds issued by the highway authorities for highway projects, public projects for sewer systems, and other municipal projects.
General obligation issues are backed by the taxing power of state that issues them, and the project securities are backed by the incomes generated by the projects being discussed. Therefore, project zero-coupon bonds are less safe.
The quality of the issue of zero-coupon bonds is very important because of the said reasons on previous sections, essentially, due that bondholders do not receive another payment that is not the payment of principal and interests once reaching maturity.
Consequently, you should not accept buying low-quality zero-coupon municipal issues because there are many good-quality issues in the market. This point is specially relevant to issues with long term maturities (over 15 years of maturity), where anything can happen to affect the issuers ability to repay the bonds. To buy a better quality of zero-coupon bond issues you should sacrifice yields slightly.
Many municipal zero-coupon issues are callable and you should check the call provision before buying. If there is an option to choose a non-callable issue before a callable issue of similar qualities, and maturity avoid buying the callable issues.
The call price as well as the call date listed in the bond?s indenture are important. The call price could be less than the market price, resulting in a loss if the issue is called, for which it would be intelligent to check the call provision first.
An issue could have a serial call which means that some bonds in the issue could be called earlier than others in the same issue.
Although municipal zero-coupon bonds are exempt from paying federal taxes, investors would like to know how the state taxes the accrued interest on the securities. Some states tax the phantom interest as it accrues, and other state tax the interest at maturity or when securities are sold.
Investors can get this information from their state revenue office before selling a zero-coupon bond; you should consult your tax advisor or with your accountant to avoid a bad consequence.