DEFINITION of 'Municipal Convertible'

A zero-coupon municipal bond that can be converted into an interest-bearing bond under certain circumstances. The municipal convertible is a zero-coupon bond, and is sold at a discount from its face value. The bondholder does not have to worry about paying tax on the appreciation which is similar to not paying tax on the interest of a regular municipal bond. Also known as Stepped Tax-exempt Appreciation on Income Realization Securities (STAIRS).

BREAKING DOWN 'Municipal Convertible'

Because these securities bear no interest payments, they're much more volatile than traditional municipal bonds. Municipal convertibles fall in value much quicker as interest rates rise, and rise in value much quicker when rates fall. An investor may want to convert to an interest-bearing bond if they want to reduce volatility, or lock in bond value if they believe rates will rise in the future.

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