Residual Interest Bond (RIB)

Residual Interest Bond (RIB)

Residual interest bonds (RIBs) are securities created when income from a municipal bond is divided into two segments. A residual interest bond is a type of inverse floating-rate bond created by dividing the income from a municipal bond into two portions: a residual interest floating-rate bond and a primary direct floating-rate bond. A residual interest bond (RIB), also known as an inverse floater or inverse floating-rate bond, is a municipal bond that has been split into two segments. A residual interest bond can be either a general obligation bond or a revenue bond, as this does not matter to the investor except for the different risk profiles of the two, which they would choose depending on their risk tolerance. The first segment of a RIB is a residual inverse floating-rate bond and the second segment is a primary direct floating-rate bond.

A residual interest bond is a type of inverse floating-rate bond created by dividing the income from a municipal bond into two portions: a residual interest floating-rate bond and a primary direct floating-rate bond.

What Is a Residual Interest Bond (RIB)?

Residual interest bonds (RIBs) are securities created when income from a municipal bond is divided into two segments. The two created segments are a residual inverse floating-rate bond and a primary direct floating-rate bond.

A residual interest bond is a type of inverse floating-rate bond created by dividing the income from a municipal bond into two portions: a residual interest floating-rate bond and a primary direct floating-rate bond.
Residual interest bonds enable municipal bond funds to promise higher current yields to their buyers.
Because of their high level of sophistication and potential volatility, most RIBs are owned by financial institutions instead of by individual investors.
The goal of RIBS is to enhance yield and assist portfolio managers in controlling the maturity of their overall portfolio.

Understanding a Residual Interest Bond (RIB)

A residual interest bond (RIB), also known as an inverse floater or inverse floating-rate bond, is a municipal bond that has been split into two segments. The first segment of a RIB is a residual inverse floating-rate bond and the second segment is a primary direct floating-rate bond.

The resulting floaters will have a reverse relationship to a reference interest rate, such as the London Interbank Offered Rate (LIBOR). The income from the municipal bond is then used to pay the coupon on the direct floater, and any remaining revenue will go toward the residual interest bond.

Purpose of a Residual Interest Bond (RIB)

RIBs enable municipal bond funds to promise higher current yields to their buyers. As rates on municipal bonds rise, holders of RIBs will own bonds that pay a lower coupon, or yield. This dropping yield drastically reduces the price of the bond on the secondary market.

Buyers of residual-interest bonds receive a higher interest rate than a conventional municipal bond would provide. However, the risk of these securities is elevated. An investor who holds an inverse floater maintains all of the underlying bond's downside risk. 

The goal of RIBS is to enhance yield and to assist individual portfolio managers in controlling the maturity of their overall portfolio. Because of their high level of sophistication and potential volatility, most RIBs are owned by financial institutions instead of by retail investors.

Municipal Bonds and Residual Interest Bonds (RIBs)

A municipal bond is a type of debt security commonly used by government entities such as states or municipalities as a means of financing large expenses.

For instance, Springtown needs to raise $5 million so the town can perform much-needed updates to its elementary school. The town releases $5 million worth of municipal bonds that investors can purchase, to be paid back to the investors at a predetermined interest rate. Municipal bond income is usually exempt from federal taxes, and sometimes state taxes as well.

There are two main types of municipal bonds: general obligation bonds and revenues bonds. With a general obligation bond, the bond is backed by the issuing entity. A revenue bond uses revenue from the project itself to back the bond. For instance, if a state releases bonds in order to fund the construction of a new toll highway, the money collected from tolls would help pay back the bond.  

A residual interest bond can be either a general obligation bond or a revenue bond, as this does not matter to the investor except for the different risk profiles of the two, which they would choose depending on their risk tolerance.

A general obligation bond is fully backed by the issuing entity and the payments made from its normal government functions, such as the collection of taxes. A revenue bond, on the other hand, only makes payments from the income generated by a specific project. If the project fails or if the income is not significant, then payments on the bond can be impacted. It is for this reason that revenue bonds carry a higher risk but also pay a higher yield.

Related terms:

Authority Bond

An authority bond is a security issued by a corporate or government agency to finance the operations of a revenue-generating public business. read more

Bond : Understanding What a Bond Is

A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. read more

Bond Market

The bond market is the collective name given to all trades and issues of debt securities. Learn more about corporate, government, and municipal bonds. read more

Debt Security

A debt security is a debt instrument that has its basic terms, such as its notional amount, interest rate, and maturity date, set out in its contract. read more

Double Barreled

A double-barreled bond is a municipal bond in which the interest and principal payments are pledged by two distinct entities—revenue from a defined project and the issuer and its taxing power. read more

Financial Institution (FI)

A financial institution is a company that focuses on dealing with financial transactions, such as investments, loans, and deposits. read more

Floater

A floater, also known as a floating rate note, is a bond whose interest payment is tied to a predetermined benchmark index, such as LIBOR. read more

Floating-Rate Note (FRN)

A floating-rate note (FRN) is a bond with a variable interest rate that allows investors to benefit from rising interest rates. read more

General Obligation (GO) Bond

A general obligation (GO) bond is backed by the credit and "taxing power" of the issuing jurisdiction rather than the revenue from a given project. read more

Inverse Floater

An inverse floater is a bond or other type of debt whose coupon rate has an inverse relationship to a benchmark rate. read more