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Securities & Investment Regulation
OTHER PFR AGENCIES
Investing Basics Online Guide
The Office of Securities makes available this basic guide to investing that covers everything you'll need to know from how to balance risk and return to the most common investment scams.
On this page:Introduction / Definitions / Before You Invest
Important Considerations / Protect Yourself Against Fraud
Setting Investment Goals / Balancing "Risk" and "Return"
Suitablility / After You Invest / Keep Your Securities Safe
Monitoring Your Account / What to Expect from Your Broker
Commissions and Churning / If You Have Problems
How to Spot a Scam / Most Common Investment Scams
Municipal Bonds / Publications
There are many types of investments and investment professionals in today's world. There is also much information available for investors, which can be one of the best protections of all against fraud, abuse, and poor investment decisions. Many problems that caused great harm to investors could have been avoided through accurate information beforehand. This section offers some suggestions about how to get access to, and use, some of such information.
Many investors dream of finding a high-yield investment with little or no risk. However, in the "real world" of investing, the greater the potential profit, the greater the risk. It is always a good idea to keep these thoughts in mind:
The word "securities" describes a wide range of investments. Essentially, a person who purchases a security has made an investment in some sort of enterprise, with the expectation of a return from that investment. Securities are "passive" investments; that is, the investor's success is primarily dependent upon the efforts of others. Therefore, it is very important for investors in securities to have accurate information and receive fair treatment. Some of the most common forms of securities are stocks, bonds and mutual funds. However, securities come in many other forms as well. Other examples of securities include promissory notes, interests in oil and gas wells, and interests in gold mines. Even a general partnership can be a security. There are many different types of investments, each with different characteristics. The following is a brief description of some of the more popular forms of securities:
Shares of common stock represent ownership, or "equity," in the company that issued the stock. As the owners of the company, shareholders participate in the company's profits through the company's payment of dividends. On the other hand, there are no guarantees; all or part of your money could be lost. Common stocks range from "blue chip" stocks issued by established companies (many of which are household names) to high-risk stocks issued by companies that are just starting out.
Instead of owning a part of the company, a bondholder has essentially made a loan to the company. The corporation which issued the bond pays interest until the bond matures and the principal is repaid. The risk of corporate default is obviously important for the investor to consider. Although the term "high yield" sounds attractive, it is important to remember that the higher the yield, the riskier the bond. Also, bonds can be bought and sold. Selling the bond prior to maturity may result in a gain or loss of principal, depending upon interest rates at the time.
Also known as "investment companies," mutual funds pool the amounts which their investors pay in to purchase their shares, and in turn invest in the securities of other companies. The value of a mutual fund's shares will vary based upon the total value of the fund's investments divided by the number of shares outstanding (net asset value). In an "open end" mutual fund, the most popular form of investment company, shareholders may redeem their shares at any time, based upon their shares' net asset value. Mutual fund shareholders are paid dividends based upon the fund's earnings after expenses. Mutual funds may charge various types of sales charges ("loads") and other ongoing expenses. Investors should be sure that they understand all such charges before investing.
Money Market Mutual Funds
This is a type of mutual fund that invests solely in short-term debt securities, such as Treasury bills and commercial paper. Interest rates vary depending upon the portfolio mix of the fund and maturity. Dividends typically are declared daily and paid monthly. Money market funds usually strive to maintain a consistent price of $1.00 per share. Although often used as a very conservative, savings-like investment, these funds, as with other securities, are not guaranteed.
As the name suggests, holders of preferred stock receive preference over the holders of common stock in case the company is dissolved, although they would still be "next in line" after creditors of the corporation, such as bondholders. In addition, preferred stockholders receive priorities in the payments of dividends, although, in return for this priority, the dividend amounts are limited to certain set amounts. Also, preferred stockholders do not have voting rights, as do common stockholders. It is sometimes said that preferred stock is an equity interest that has certain characteristics which resemble those a bond.
State or Municipal Bonds
These bonds are issued by state or local governments to finance various projects, such as highways, bridges, or schools. Bond maturities can run from less than one year to over 30 years. Although these are also frequently considered to be fairly conservative investments and may enjoy special tax treatment, they, also, are not actually guaranteed. There have in fact been occasional, although rare, defaults in the category of municipal bonds.
United States Government Securities
The U.S. Government issues a number of types of securities. Since they are backed
by the U.S. Government, investors consider these to be very safe. However, if an
investor is not going to hold the bond until maturity, there may still be interest-rate
risk. Interest earned on these investments is exempt from state and local taxes.
The three major categories of these government-issued securities differ in their
maturity (time period) and the minimum investment required.
Zero Coupon Bonds
These are corporate or government bonds which investors purchase at a "deep discount" (well below face value). The investor will know in advance what the bond will pay at its maturity, but will not receive interest in the meantime. As with all bonds, these are also subject to interest-rate risk.
Investment firms and professionals
Besides understanding the nature of the security in which you invest, it is important also to understand the firms and individuals with whom you will be dealing. The following is a brief description of the types of entities whose business involves serving you, the investor. In all of these cases, you can check on the necessary licenses, and receive information concerning disciplinary records, by getting in touch with the Office of Securities.
This is the "official" name for what are commonly referred to as securities brokerage firms. Investors maintain their securities accounts with such firms, which need to have licenses to do such business. Sometimes, a local office will use a "doing business as" name, but will in fact be a branch of a larger firm, which may not even be located in the same state. Consumers should be sure that they know the name of the actual broker-dealer firm with whom they are doing business.
These are the individuals who work for the broker-dealer firms described above, and with whom investors deal directly when effecting transactions in their accounts. They are, or course, most commonly referred to as stockbrokers. They receive commissions when you purchase or sell a security. When you rely on their advice or expertise, they owe you a fiduciary duty; that is, the law requires them to have your interest in mind. Investors should never feel embarrassed to ask questions about the investments which their agent recommends, or about the agent's compensation. Also, as always, investors are encouraged to check with the Office of Securities for licensing and disciplinary information.
Advice, of course, is very valuable to investors. Consequently, there is another type of securities license which deals with the sale of advice. Investment advisers and their representatives come in many varieties. Some manage investors' money, and receive payment only from their clients. They are known as "fee-only" money managers. Their clients' trades are placed through unaffiliated broker-dealers. Other investment advisers provide planning services for their clients' financial needs. Frequently referred to as "financial planners," some are fee-only as well, and others also maintain an agent license through a broker-dealer, and also therefore may receive commissions.
It is very important for an investor to know exactly what kind of services an investment adviser offers. The law concerning investment advisers provides significant assistance in this regard. Potential clients must receive a "disclosure brochure" (often in the form of the "ADV Form, Part II"), a regulatory document prepared for this purpose. If you are shopping for an investment adviser, you should always examine such documents closely. They provide much useful information. You should also check with the Office of Securities for licensing and disciplinary information.
Risk and Return
No matter how you choose to invest your money, all securities involve a degree of risk. Risk and return go hand in hand. Higher returns mean greater risk, while lower returns provide greater safety.
Remember: if you can't afford to lose or take any risks with your money, you are not ready to invest.
U.S. Treasury Bills (T-bills) are the benchmark of minimal-risk investments. If an investment is presented as very low risk, it should produce a rate of return similar to the rates paid on T-bills.
State securities offices regulate the securities industry in the various state jurisdictions. Every state has such an agency, created to administer the respective state's securities laws. Maine has had a securities law since 1913. The Maine Uniform Securities Act, a 2005 revision of the original law, is the latest iteration. The Maine Office of Securities can provide investors with important information about the registration or exemption status of the securities in which the investor is interested, as well as licensing and disciplinary records for broker-dealers, agents, investment advisers, and investment adviser representatives. In addition, in the event of a problem, the Office of Securities is often a good place for an investor to inquire. There may be an issue with which we can help.
Securities are regulated through both the state and federal governments. At the federal level, the Securities and Exchange Commission(SEC) administers the various federal laws, the most significant of which are the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940.
The National Association of Securities Dealers (NASD) handles many of the ongoing aspects of broker-dealer and agent regulation. Known as a "self-regulatory organization," the NASD has these responsibilities through, essentially, a delegation of certain authority from the SEC.
Before you invest, consider your complete financial situation, looking at both your current and future needs. In general, investors should avoid higher-risk investments unless they have a steady income, adequate insurance, and readily accessible cash reserves in case of a loss, and most important, are willing to accept risk to their principal.
Call the Maine Office of Securities at (207) 624-8551 (toll free from within Maine (877) 624-8551) for information on any of the following:
You should also thoroughly understand the investment, including the risks involved, before you invest. Contact the appropriate regulatory agencies. Visit your local bookstore or library and educate yourself on appropriate investment subjects that interest you. Be informed and certain of what you are buying before you invest.
When you are contacted by phone or in person to make an investment, you should ask the following questions and write down the responses:
Asking these questions is the beginning of the investigatory process. But remember, a skillful presenter will have answers to all of your questions. It is your responsibility to verify the information you receive in response to the questions asked above. You can determine if some of the information you have been given is accurate by calling the relevant numbers and firms listed.
All investments carry a risk, even if all of the above steps indicate that the company, salesperson, and securities you want to invest in are solid and legitimate. However, not all risk is the same. Generally, the higher the return you want on your investment, the greater risk you are taking.
No amount of investigation will change this basic rule:
Ask yourself, "What do I want to accomplish through my investments?" For most investors,
the following investment goals or objectives, or some combination of these, provide
an initial answer to that question:
As an investor, you choose your investment goals with an emphasis on one or more of the above categories. You may also wish to allocate portions of your investment portfolio to more accurately express your investment goals.
Of course, setting a goal and reaching it are two very different things. You may need professional assistance to realize your investment goals and to achieve your financial objectives.
If you choose to work with a broker, communicate your investment goals and financial objectives clearly. Put them in writing, and keep a copy for your own records.
Remember, the more money you want to make from your investment, the more risk you must be willing to take. Risk means that you may lose all or part of your principal. If a high level of risk makes you uncomfortable, select your investments accordingly.
The basic concept in securities law regarding whether a recommended investment is appropriate for a particular investor is known as "suitability." Any investment professional should be able to articulate why an investment recommendation is suitable for your needs. Do not be afraid to ask many questions, no matter how basic they may seem to you.
There are many sources of information about any company in which you may be contemplating making an investment. If you don't know where to look, start by contacting the Maine Office of Securities. Securities must be registered or exempt from registration in each state where they are sold. Information about the company may be available to the public. You should also ask your brokerage firm or investment adviser to assist you in gathering information about the company in which you may invest.
Most companies whose stock is traded "over the counter" or on a stock exchange are required to file "full disclosure" reports on a regular basis with the Securities and Exchange Commission (SEC). These comprehensive reports are available for a modest copying charge by writing to:
Public Reference Room, Mail Stop 1-2
Pay attention to business and financial newspapers in your area. Often, these periodicals provide in-depth coverage about a specific company or segment of the industry. Check with your local reference librarian for assistance in identifying appropriate investment-related materials. One of the very best ways for an investor to protect himself or herself is through adequate information, education, and consultation of available resources.
Your investment responsibilities don't end once you've selected a broker and an investment.
Some of the more important responsibilities are:
If something goes wrong, it's important to recognize the problem quickly and take appropriate action.
When you purchase shares of stock or a bond, you may receive a certificate representing your ownership. These valuable documents should be kept in a safe place. It is costly and time-consuming to replace a certificate if the original is lost or destroyed.
If you purchase stock through a brokerage firm, you usually have three choices regarding how your stock certificates are handled:
Be sure to discuss these options with your broker and decide which is right for you. Ask whether the broker charges additional fees for holding stock in the street name, and ask about any related custodial fees.
After you've invested, you should receive periodic account statements. You will also receive confirmations for each trade as it occurs. Don't throw them away. Read each confirmation and account statement, and make sure that they accurately reflect the trading activity that you have authorized in your account. Check to see how much of a commission you were charged. You should expect to be informed in advance of any increases in charges, such as commissions and custodial fees.
As you monitor your confirmations and account statements, follow up immediately on anything that you do not understand. Investors who fail to do so are sometimes said to have "ratified" transactions that otherwise might not have been appropriate or authorized. This can make pursuing your legal options that much more difficult. If you do not receive prompt assistance from the broker-dealer, contact the Office of Securities.
Designate a file folder for storing all investment-related information. As soon as you've received and reviewed the confirmation slips and monthly statements from your broker, file them. If you have a dispute with your broker regarding your investment, this file may be invaluable.
When you fill out your new account form, you provide the broker with information about your financial situation, your investment objectives, and the level of risk you are willing to take.
You have a right to expect your broker to follow your instructions and to recommend appropriate investments. As noted above, securities regulators use the term "suitability" to refer to the question of whether a broker's investment recommendations are appropriate for a given investor.
Although you are not protected from a decline in the value of securities due to normal market risks, you may have certain legal rights if a broker's recommendations were unsuitable based on your financial objectives and situation.
A broker's earnings are based on sales commissions or markups. The more buying and selling a broker does for each customer, the higher his or her income. Unnecessary buying and selling is called churning. If you suspect that certain recommendations have been unsuitable or that your account is being churned, immediately contact the Office of Securities.
Regardless of how careful you are in selecting a broker, problems may still occur. Contact your broker at the first sign of trouble and clearly communicate your concerns. Ask your broker for a written reply explaining the handling of your particular problem. You also should file a written report of your problem with the home office of the broker's firm. Call the Office of Securities for the appropriate contact person and address.
If you aren't satisfied with the result, or if this process takes more than 7 to 10 days to complete, contact the Office of Securities. Although your initial contact may be over the phone, we may ask you to document your complaint in writing. You should be prepared to list specific details of your investment, including dates, amounts, and types of securities. Often, copies of your account statements or other documents attached to your complaint will help to explain the situation.
Always keep a copy of any complaint letters you send and the responses you receive. These documents may be of great benefit to you later.
You may also need to consider consulting a private attorney for assistance in resolving a securities dispute. While regulators will investigate for violations of securities laws and rules, regulatory agencies cannot directly represent investors. In some instances, the only way to recover your investment may be through a private lawsuit or arbitration proceeding.
There are many investment opportunities awaiting you in today's complex financial world. As an investor, your task while meeting your personal investment goals is to sort out those investments that have the greatest potential. You may well find yourself solicited by telephone calls, mailings, and door-to-door salespersons. Many investment scams start on the telephone. Be prepared to deal with investment scam artists.
Indicators that the caller could be a crook:
A boiler room is often just a short-term rented apartment or office with multiple phone lines and an impressive-sounding address. Boiler rooms earn their name from the "heat" and high pressure generated by the callers as they try to convince investors to part with their money.
In many cases, either the company or the product does not really exist, or it doesn't operate as represented. Telephone pitches are read from prepared scripts, with quick answers to the most common objections. Your phone number may have been obtained from phone directories, purchased lists, or newspaper articles. Boiler-room operators have even been known to call recent widows and widowers or people who have lost large sums of money, offering to "help" recover the losses quickly and effortlessly.
Pyramid promotions focus on the quick profits to be earned from recruiting other investors, who then will recruit others, and so on. Little mention or emphasis is placed on the product or service to be sold. The fraud derives from the ever-decreasing number of potential investors in a given area. The common elements of a pyramid scheme involve the following:
The emphasis is to get others to invest. True pyramid schemes are illegal in Maine, but are difficult to prosecute. Victims' money is often filtered up through the pyramid and lost. Sooner or later, all pyramid schemes collapse of their own weight (taking many investors down with them, of course).
These loans are usually offered to desperate borrowers who have exhausted all of the traditional approaches to financing. Loans are arranged and promised only upon payment of an "up-front" or "advance fee." It is common for the promoter to represent the source of funds as foreign investors or an offshore bank. Loan amounts are typically very large ($5 to $100 million), and offer long repayment terms at below-market rates of interest. Minimal qualifications, other than the advance fee payment, are required. The promoter takes the advance fee and never delivers the loan.
Promoters offer high rates of return on the various impressive-sounding investments. However, instead of using the money as promised, new investors' money is used to pay the monthly "interest" or "return" to earlier investors. These "satisfied investors" then report the high returns to their friends, who in turn invest in hopes of achieving the same above-average returns. In a Ponzi scheme, investors are not in fact investing in an underlying business, even though they believe they are. Early investors are simply being paid with the funds received from later investors. The scheme only continues as long as new investors provide additional funds. When the scheme collapses (as it always does), current investors lose their money and the promoters walk away rich.
Loan Roll Programs/Prime Bank Notes
These investments are similar in many respects to the advance-fee loan schemes described above. Promoters offer the "little guy" a chance to pool money with other investors to buy bank notes internationally, often touting a large offshore bank as instrumental in the deal.
Investments range from a few thousand dollars to a hundred thousand dollars or more. Returns of fantastic wealth are promised, sometimes even in the $100 million range. Details about how the program works are either unavailable or, when examined closely, nonsensical. Investors' money is rarely recovered.
Gold and Silver Mines
These speculative investments typically offer new or secret methods for reclaiming mineral reserves from untested or abandoned mines, or even the recovery of microscopic traces of valuable minerals from soil in your geographic area "where no one else would think to look!" These are classic frauds. Often, the promoter will base a mining forecast on an unknown expert's geological report or prediction, or will offer part of a valid report out of context. Promoters exaggerate the quality and quantity of the minerals to be extracted, while downplaying the expense or actual likelihood of recovering them.
By acquiring interests in a "proven" oil field or in the immediate vicinity of other proven oil fields, investors are promised "can't-miss opportunities" for great wealth. These investments are frequently sold to people who live far from the oil company's headquarters, which may be nothing more than a rented trailer.
As with gold and silver mines, promoters frequently offer new and secret methods for reclaiming missed oil reserves on previously drilled oil fields.
Coins and Precious Metal Schemes
Promoters offer "investment-grade" gold and silver coins, claiming their present value can be independently verified, and promising tremendous future profits, usually based on some current or political event.
For the cost of your investment and a nominal storage fee, the promoter will purchase the coins and bullion for you and have them delivered to and stored in a large, well-known bank, nearly always outside of your geographical area. Often these promoters promise the opportunity to "leverage" your purchase. Leveraging, in theory, is like buying on margin, in that you only make a down payment toward the total cost of the metal you wish to buy. The rest of the money is advanced or loaned to you, with the precious metal serving as collateral. For instance, for $10,000, you might purchase 22 ounces of gold at $450 and ounce. By leveraging your purchase at 20 percent down, you could purchase five times as many ounces, or 110 ounces.
The problem with a leveraged purchase occurs when the value of this precious metal decreases. As the buyer, you are responsible to cover the downturn in value by putting in more money. If you fail to cover the downturn, your precious metal is sold (often at a discount), and you are liable for the difference. Leveraging is extremely risky, and not recommended for the casual investor.
Some schemes charge extremely high commissions, so that there must be a great increase in the value of coins or metals before you see a profit. Other schemes don't even bother to purchase the coins or metals. The promoters just take your money and move on to the next town. If you want to purchase precious metals, talk with the local merchants who will deliver the goods to you and who have local reputations to protect.
What Are Municipal Bonds?
Municipal bonds are debt obligations issued by states, cities, counties, and other governmental entities to raise money for public purposes -- such as building schools, highways, hospitals, sewer systems, and other special projects.
When you buy a municipal bond, you are lending money to the "issuer," the governmental entity that issued the bond. In exchange, the governmental entity promises to pay you a specified amount of interest, usually semiannually, and return your money, also known as "principal," on a specified maturity date.
A primary feature of many municipal bonds is that the interest you receive is generally exempt from federal income tax. The interest may also be exempt from state and local taxes if you live in the state where the bond is issued. For example, the State of Maine does not impose an income tax on bonds that the State or one of its municipalities has issued to Maine residents. Please note, however, that although the interest earned on the bond is not taxed, you will be subject to capital gains tax if the price of the bond at the time it matures or at the time you sell it is more than your original investment.
Bonds that mature in less than a year are often called "notes" and are generally issued to raise money to cover municipal needs for immediate capital. It is expected that the issuer of the notes will be able to return your money based on future revenues such as taxes, federal or state aid payments, or proceeds from other bonds. Bonds that mature in a year or more are generally issued to finance longer-term capital projects. "General obligation" bonds are usually voter-approved and supported by the issuer's taxing power. "Revenue" bonds are supported by the revenue derived from tolls, charges, or rents paid by the users of the public projects or facilities that are built with the proceeds of the bond issue.
Some information about how Maine bonds are created can be found on the website of the Maine State Treasurer's Office at http://www.maine.gov/treasurer/debts_bonds/.
How Much Does It Cost to Invest in Municipal Bonds?
Most tax-exempt municipal bonds are issued in denominations of $5,000 or multiples of $5,000, meaning that you will probably need a minimum of $5,000 to buy a municipal bond from an issuer.
You can find the current list prices of widely traded municipal bonds in financial newspapers such as The Wall Street Journal, Investor's Business Daily or Barron's, and in the business pages of some major daily newspapers. You can also find this information on the Internet, either via the industry's trade group, the Bond Market Association, at http://www.investinginbonds.com, or at other websites (though many of the latter will charge a subscription fee). In addition, note that the list prices are generally based on $1 million lots that would be sold at a volume discount, so an individual investor's purchase of a smaller amount may cost more. Eventually, real-time price information will be made available by the Municipal Securities Rulemaking Board (MSRB), an organization that regulates the brokers and banks that sell municipal securities. The MSRB's website, http://www.msrb.org, also contains a helpful glossary of terms relating to municipal securities.
Municipal bonds are bought and sold between broker-dealers and investors much like other securities and debt instruments, which means that the broker-dealers will make a profit by selling municipal bonds to their customers. Do not hesitate to ask your broker if you want more information on the profit that they make in selling these bonds. Also, in calculating what your return would be on a municipal bond, make sure to factor in the commission and any other fees you would have to pay.
In addition, when purchasing a bond that is not newly issued (i.e. when buying a bond from another investor rather than from the issuer), be sure to ask how much you will have to pay in accrued interest. You will need to pay the bondholder the amount of interest earned on the bond since the last interest payment. For example, if the bond pays interest semiannually (e.g. June 15th and December 15th) and you buy the bond on July 15th, you will be responsible for paying that investor for the one month of interest that she has earned since June 15. After you buy the bond, you will receive the next interest payment on December 15th, which will cover the interest earned from June 15th through December 15th. Hence, the interest you pay to the seller at the time you buy the bond will be returned to you on the next interest payment date.
The Maine State Treasurer's Office maintains a list of broker-dealers who sell Maine bonds on its website, at http://www.MuniOS.com
What Is the Difference Between Current Yields and Yields to Maturity?
The "current yield" of a bond is a percentage that tells you how much interest you will make in one year on the bond that you purchased. If you buy a $5,000 bond at face value and with a 5% interest rate, you would be paid $250 per year in interest, for a current yield of 5%. The same bond, if purchased at a discount price of $4,000, would have a current yield of 6.25%. If the bond was purchased at a premium price of $6,000, it would have a current yield of 4.17%.
The "yield to maturity" is the rate of return you receive by holding a bond until it matures.
Please be aware that, as with most investments, a higher yield may well carry a higher investment risk.
How Safe Are Municipal Bonds?
As with an investment in any other bond, a potential buyer should consider whether the financial condition of the issuer makes it likely that the issuer will be able to meet its obligations, including the timely repayment of all bonds issued. The bank or broker who is selling the bond should provide you with the issuer's "official statement" or "offering circular." Issuers also provide information about their financial condition through Nationally Recognized Municipal Securities Information Repositories. A list of these repositories is available at the U.S. Securities and Exchange Commission's website at http://www.sec.gov/info/municipal/nrmsir.htm. In addition, information about bonds issued by Maine and its municipalities is available from the Maine Municipal Bond Bank at (207) 622-9386 and at http://www.mainebondbank.com.
Issuers of municipal bonds also receive credit ratings from agencies such as Moody's Investors Service, Standard & Poor's, and Fitch Ratings. The research departments of some banks and broker-dealers also analyze and report on municipal securities. Bond ratings reflect a professional assessment of the issuer's ability to repay the bond's face value at maturity. The highest credit rating is "AAA." Please be aware, however, that a high credit rating does not insulate you from changing market conditions and thus it is still possible that you could lose money on your investment.
The fixed interest payment, also known as the "coupon rate," does not change over the life of a municipal bond. What does change, based on market conditions, is the value or market price of the bond itself. If you sell your municipal bond before maturity, you will receive the current market price, which may be more or less than the price you had paid for it. Municipal bond prices tend to increase when nationwide interest rates decline. Likewise, municipal bond prices tend to decline when those interest rates rise.
Typically, the coupon rate will be higher for bonds that take more time to mature, because of the amount of interest rate risk that the investor has to assume. Nobody knows what direction (up or down) interest rates will go in the future. If interest rates increase while you are holding your bond, you will be receiving a lower coupon rate than what will be offered on similar, newly issued bonds. Therefore, by investing in a bond today at a certain fixed coupon rate, you take the risk that you will earn less interest than if you wait and buy a similar bond at some later time. On the other hand, buying the bond now may allow you to lock in a higher coupon rate than what will be available for a similar bond down the road.
What Is a Callable Bond?
Many municipal bonds allow the issuer to redeem or pay off the bonds before the specified maturity date. Bonds with this kind of provision are "callable" bonds. When an issuer calls its bonds, it pays investors the call price (usually the face value of the bond) together with accrued interest to date and, at that point, stops making interest payments.
An issuer may choose to redeem a callable bond when current interest rates drop below the interest rate on the bond. The issuer can save money by paying off the bond and issuing another bond at a lower interest rate. This is similar to refinancing the mortgage on your house so you can make lower monthly payments. Callable bonds are more risky for investors than non-callable bonds because an investor whose bond has been called is often faced with reinvesting the money at a lower, less attractive rate. As a result, callable bonds often have a higher annual return to compensate for the risk that the bonds might be called early.
You should be cautious in buying a callable bond at a premium (above the bond's face value), especially if the callable date is in the near future. If your bond is called, you may not get back what you paid. You will be paid the call price, which often is only the face value of the bond.
Before you buy a municipal bond, you should always ask your broker if there is a call provision and, if so, under what circumstances the bond can be called. You should also read the issuer's offering documents. If you find that you have bought a callable bond and the call feature was not disclosed to you, contact the Office of Securities at (207) 624-8551 and ask to speak to an investigator.
What Other Special Features May a Municipal Bond Have?
Some municipal bonds may be backed by municipal bond insurance, which means that an insurance company guarantees that you will receive timely payments of interest and principal in case the issuer defaults.
Some municipal bonds are sold as "floating-rate" or "variable-rate" bonds, which means that your interest payments are not fixed but fluctuate up or down depending on nationwide interest rates.
"Zero-coupon," "compound-interest," and "multiplier" bonds are issued at a deep discount of the maturity value and have no periodic interest payments. You receive one lump payment at maturity equal to the price you paid for the bond plus interest compounded semiannually at the original interest rate. Prices of such bonds tend to be volatile.
"Put" bonds allow you to redeem the bond at face value on a specified date long before the maturity date.
For a list of brochures published by the Maine Office of Securities go to our Securities Brochures page.
Last Updated: July 10, 2012
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