State and Local Governments
This report expands on the topic of municipal bonds and discusses the different incentives attached to government bonds. These debt instruments are issued by states and government bodies to finance their investments and spending. In doing so, governments become lenders, which allows them to support specific sectors to help stimulate their economies. For example, how have some governments supported businesses during the coronavirus pandemic?
Classifying State and Local Debt Instruments
State and local debt can be classified based on (1) the maturity (or term), which is the length of time before the principal is repaid; (2) the type of security, which is the financial backing for the debt; (3) the use of the proceeds for either new facilities or to refinance previously issued bonds; and (4) whether the type of activity being financed has a public or a private purpose.
The risk associated with a bond is also an important factor, as nearly every bond issued by a state or local government is rated based on the probability of default. The privately managed rating agencies incorporate all of the above factors as well as the financial health of the entity issuing the bonds when arriving upon a bond rating. The higher the default risk, the lower the rating.