"An insured municipal bond is safer than an uninsured municipal bond." Indicate whether you agree or disagree with this statement

Question

What will be an ideal response?

Answer 1

Everything else being equal, an insured municipal bond is safer. However, generally speaking, municipal bonds that are insured are riskier than those not insured especially if they are of inferior quality. Thus, the insurance does not guarantee they are safer than an uninsured municipal bond. More details are supplied below.

Insured bonds, in addition to being secured by the issuer's revenue, are also backed by insurance policies written by commercial insurance companies. Insurance on a municipal bond is an agreement by an insurance company to pay the bondholder any bond principal and/or coupon interest that is due on a stated maturity date but that has not been paid by the bond issuer. When issued, this municipal bond insurance usually extends for the term of the bond issue, and it cannot be canceled by the insurance company.

Because municipal bond insurance reduces credit risk for the investor, the marketability of certain municipal bonds can be greatly expanded. Municipal bonds that benefit most from the insurance would include lower-quality bonds, bonds issued by smaller governmental units not widely known in the financial community, bonds that have a sound though complex and difficult-to-understand security structure, and bonds issued by infrequent local-government borrowers who do not have a general market following among investors.