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Municipal bonds are backed by dedicated taxes or revenue sources related to specific projects, or by the full faith and credit of the issuer – typically the municipality the bonds are intended to benefit.

Municipal bonds can generally be divided into general obligation bonds and revenue bonds. The difference between the two categories is principally the source of interest and the principal payments.

While municipal bonds are commonly tax-exempt, at least in regard to federal income taxes, bonds come in a variety of forms, with varying structures of payments and tax consequences as well. Therefore, it is important for investors to research any municipal bond issue prior to deciding to purchase bonds.

General Obligation Bonds

General obligation bonds are essentially backed by the full faith and credit of the governmental entity that issues the bonds, although the backing for a specific bond issue may be from dedicated tax sources or simply from the general funds of the governmental entity. General obligation bonds are not typically backed by specific project fees, such as highway use or other toll fees.

Revenue Bonds

Revenue bonds are backed or secured by revenues from the issuer or by specific taxes, which can range from sales taxes to facility use taxes. The issuers of revenue bonds are commonly private sector entities (such as a school or hospital), non-profit organizations, or specific municipal entities (such as the public transportation authority or housing authority).

Insured Municipal Bonds

Some municipal bonds, either general obligation or revenue bonds, are insured. In these instances, the issuer obtains an insurance policy from a commercial insurance company that insures the payment of both interest and principal payments in the event that the bond issuer defaults on making the payments as scheduled. When considering investments in insured bonds, investors consider the credit rating of the bond issuer as well as the credit rating of the insurer.

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