What is a Municipal Bond?
Bonds issued by a state, city, or local government are called municipal bonds.
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).
Interest on municipal bonds is 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.
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. 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.
Municipal bonds typically come in $5,000 par values.