Definition
Bond issued by
a state, city, or local government. Municipalities issue bonds to
raise capital for their day-to-day activities and for
specific projects that they might be undertaking (usually pertaining to
development of local infrastructure such as roads, sewerage, hospitals
etc). intereston municipal bonds are generally exempt from federal tax.
In the case that the bond is bought by a resident of the state that
issued the bond, the interest payments are also exempt from state tax.
Interest payments are further exempt from local tax if they are bought
by residents of the locality that issued the bond. Capital gains however
are taxable. Given the tax-savings they offer, municipal bonds are
often bought by people who have large tax burdens.
Yields on municipal bonds are often lower than corporate or Treasury bonds with comparable maturities,
because of the important advantage of not being taxed at the
federal level. In general, municipal bonds are considered safer than corporate bonds,
since a municipality is far less likely to go bankrupt than a company.
Some municipal bonds can also be insured by outside agencies.
These companies will promise to pay the interest and principal if
the issuer defaults.
Both issuers and bondholders can carry this insurance, though
a bondholder would need to have a large stake to get the coverage. There
are two common types of municipal bonds:
general obligation and revenue. General Obligation (GO) bonds
are unsecured municipal bonds that are simply backed by the full faith
and credit of the municipality. Generally, these bonds have maturities
of at least 10 years and are paid off with funds from taxes or
other fees. Revenue bonds are used to fund projects that will eventually
create revenue directly, such as a toll road or lease payments for a
new building.
The revenues from
the projects are used to pay off the bonds. In some cases the issuer is
not obligated to pay interest unless a certain amount of revenue is
generated. Municipal bonds usually come in $5,000 par values and
usually require a minimum investment of $25,000 in order to get the
best price. also called muni.
