Funds generated from the sale of municipal bonds may go to provide for unspecified, general government financial needs, or they may be specifically designated to fund a public works project. Common projects funded by municipal bonds include roads and bridges, schools, hospitals and even sports stadiums. Municipal bonds are sometimes issued by a government entity such as a housing or port authority.

Municipal Bond Risk

Municipal bonds are regarded as very safe investments because they are issued by government entities that have the power to tax to raise funds to pay off the bond obligations. Overall, default rates on municipal bonds remain lower than the default rate on corporate bonds. Municipal bonds are not considered as risk-free as Treasury bonds (T-bonds) backed by the U.S. Treasury.

The most distinguishing feature of municipal bonds is that, unlike corporate bonds, the interest income they generate is usually exempt from federal income taxes. Additionally, municipal bonds may or may not be exempt from state or local taxes.

Types of Municipal Bonds

Several types of municipal bonds exist. The most common type is a general obligation, or GO, bond. GO bonds are for general purposes, not a specific project. They are considered very low risk and offer relatively lower yields. GO bonds have to receive voter approval before issuance.

Revenue bonds are backed by a designated revenue source and are typically used for funding the construction of a facility. An example of a revenue bond is a bond to fund the construction or expansion of an airport, funded with airport usage fees paid by airlines. Revenue bonds offer higher yields than GO bonds.

Short-term bonds with maturities less than one year, used to fund budget shortfalls or meet cash flow needs, are issued as commercial paper bonds. These bonds are often backed by a bank letter of credit. They offer relatively low yields due to the short time frame to maturity.

Private activity bonds are those used to fund private sector projects that qualify as tax-exempt because they serve a public good. These bonds carry higher risk and offer correspondingly higher yields.

  1. How are municipal bonds taxed?

    Discover information about the various tax implications for municipal bonds and zero-coupon municipal bonds at the state ... Read Answer >>
  2. What forms of debt security are available for the average investor?

    Discover the various different types of debt securities, issued by government entities or corporations, that are available ... Read Answer >>
Related Articles
  1. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks.
  2. Investing

    A Look at the Pros and Cons of Muni Bonds

    Considering muni bonds? Here's a look at their pros and cons.
  3. Investing

    Do Municipal Bond Mutual Funds Offer a Tax Incentive?

    Learn about individual municipal securities and municipal bond funds, whose principal stability and tax-free yield appeal to high-income investors.
  4. Investing

    Muni Bonds, Taxable Bonds or CDs: Which is Best?

    Here's how to tell if municipal bonds are a better investment than taxable bonds or CDs.
  5. Investing

    5 Reasons to Invest in Municipal Bonds When the Fed Hikes Rates

    Discover five reasons why investing in municipal bonds after the Fed hikes interest rates, and not before, can be a great way to boost investment income.
  6. Financial Advisor

    Why You Should Invest In Municipal Bond ETFs

    These versatile instruments have become popular with investors in higher tax brackets and fill a specific niche in the wide selection of fixed-income offerings.
  7. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  8. Investing

    Taxation rules for bond investors

    Several factors affect the taxable interest that must be reported. Learn more here.
  9. Investing

    4 Tax-Free Muni Bond ETFs to Consider

    Tax free municipal bond ETFs are an excellent way to build wealth slowly. Here are 4 you should consider.
  10. Investing

    Surprise! The Best Long-term Bond Investment May Be Savings Bonds

    A 20-year Series EE savings bond pays more interest than a 20-year Treasury bond. So are government-issued long-term bonds the best bet going?
  1. Municipal Bond

    A municipal bond is a debt security issued by a state, municipality ...
  2. Municipal Bond Fund

    A municipal bond fund is a fund that invests in municipal bonds.
  3. Private Purpose Bond

    A type of municipal bond that is issued to finance a project ...
  4. Double Barreled

    A double barreled bond is a municipal bond in which the interest ...
  5. Combination Bond

    A bond, typically a municipal bond, that has financial backing ...
  6. Bond Buyer 20

    A representation of municipal bond trends based on a portfolio ...
Hot Definitions
  1. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  2. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  3. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  6. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
Trading Center