- Municipal bonds are issued by local governments, such as states, cities and counties. Sometimes municipal bonds are issued to finance certain projects, such as infrastructure, while other times they are designed to secure the city's finances. Not all cities have good credit ratings. Therefore, to sell the bonds at lower rates of interest, they may choose to pay a company to insure the bonds.
- There are a number of companies in the business of insuring bonds. These bond insurers essentially indemnify municipal bonds against default. If the municipality that issued the bonds fails to make a payment, the bond insurer agrees to pay the payment in its stead. This provides bond investors greater confidence and allows the municipality to receive a lower rate of interest than its credit rating would normally allow.
- Just as the bond issue itself has a credit rating, so, too, does the municipality and the bond insurer. The interest rate that investors demand on the bond depends in large part on the credit rating of the parties issuing and guaranteeing the bonds. If the bond issuer's rating is high, the investors are more likely to demand a lower rate of interest, as the bond is more secure.
- Credit rating agencies often shift the rating they give to organizations. These changes can come about for many reasons, including changes in the economy or changes in the financial position of the organization. For example, a credit rating agency may raise or lower the rating of a bond insurer. A change in the rating of a bond insurer translates into a change in the interest rates that bonds it insures can command.
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