Loading the player...

What is a 'Municipal Bond'

A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. Municipal bonds are exempt from federal taxes and from most state and local taxes, making them especially attractive to people in high income tax brackets.

BREAKING DOWN 'Municipal Bond'

A municipal bond is a debt obligation issued by a nonprofit organization, a private-sector corporation or another public entity using the loan for public projects such as constructing schools, hospitals and highways.

Types of Municipal Bond

A municipal bond is categorized based on the source of its interest payments and principal repayments. A bond can be structured in different ways offering various benefits, risks and tax treatments. Income generated by a municipal bond may be taxable. For example, a municipality may issue a bond not qualified for federal tax exemption, resulting in the generated income being subject to federal taxes.

A general obligation bond (GO) is issued by governmental entities and not backed by revenue from a specific project, such as a toll road. Some GO bonds are backed by dedicated property taxes; others are payable from general funds.

A revenue bond secures principal and interest payments through the issuer or sales, fuel, hotel occupancy or other taxes. When a municipality is a conduit issuer of bonds, a third party covers interest and principal payments.

Municipal Bond Risks

Default risk is low for municipal bonds when compared to corporate bonds. However, revenue bonds are more vulnerable to changes in consumer tastes or general economic downturns than GO bonds. For example, a facility delivering water, treating sewage or providing other fundamental services has more dependable revenue than a park's rentable shelter area.

As a fixed-income security, the market price of a municipal bond fluctuates with changes in interest rates: When interest rates rise, bond prices decline; when interest rates decline, bond prices rise. In addition, a bond with a longer maturity is more susceptible to interest rate changes than a bond with a shorter maturity, causing even greater changes in the municipal bond investor’s income. Furthermore, the majority of municipal bonds are illiquid; an investor needing immediate cash has to sell other securities instead.

Many municipal bonds carry call provisions, allowing the issuer to redeem the bond prior to the maturity date. An issuer typically calls a bond when interest rates drop and reissues municipal bonds at a lower interest rate. When a bond is called, investors lose income from interest payments and face reinvesting in a bond with a lower return.

RELATED TERMS
  1. Municipal Bond Fund

    A mutual fund that invests in municipal bonds, or "munis." Municipal ...
  2. Unlimited Tax Bond

    A municipal bond that is backed by the pledge of the issuer (generally ...
  3. Net Debt To Estimated Valuation

    A ratio comparing the net value of a municipal bond issue to ...
  4. Private Purpose Bond

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

    A municipal general obligation bond in which the cash flows are ...
  6. Combination Bond

    A bond, typically a municipal bond, that has financial backing ...
Related Articles
  1. Investing

    A Look at the Pros and Cons of Muni Bonds

    Considering muni bonds? Here's a look at their pros and cons.
  2. Financial Advisor

    How to Find the Best Bets in Muni Bonds

    Approach investing in municipal bonds the same as you would investing in stocks.
  3. Financial Advisor

    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.
  4. 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.
  5. Investing

    The Top 5 Municipal Bond Funds for 2016

    Understand how the addition of municipal bond mutual funds can enhance a portfolio, and learn the top-rated municipal bond funds to consider for 2016.
  6. Investing

    Think Twice Before Buying Tax-Free Municipal Bonds

    Municipal bonds are relatively safe, tax-exempt securities--but they are not without drawbacks. Due diligence is required.
  7. Investing

    What's a Tax-Efficient Investment for a Large Sum?

    Here's how to invest a large sum, such as assets from a profit-sharing plan, with a mind toward tax efficiency.
  8. Investing

    The Top 5 Municipal Bond ETFs for 2016

    Learn about exchange-traded funds that invest in municipal bonds issued by local U.S. municipalities with returns on bonds exempted from federal tax.
  9. Investing

    How to Diversify with Muni Bond ETFs

    Thinking of diversifying with bonds? Consider these muni bond ETFs.
  10. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
RELATED FAQS
  1. What do cities do with the funds generated from municipal bonds?

    Learn more about municipal bonds, including the various types of bonds issued and the purposes of municipal bond funds, such ... Read Answer >>
  2. How are municipal bonds taxed?

    Discover information about trading municipal bonds, specifically the various tax implications municipal bonds have at state ... Read Answer >>
  3. Where can I buy government bonds?

    The type of bond determines where you can purchase it, so you need to decide which type of bond you would like to purchase ... Read Answer >>
  4. What is a triple tax-free municipal bond?

    At its core, a triple tax-free municipal bond is just like any corporate bond: it is a debt instrument, a loan given to a ... Read Answer >>
  5. How stable are municipal bonds?

    Read about the safety and stability of the municipal bond market, and learn how that stability has been undermined since ... Read Answer >>
Hot Definitions
  1. Promissory Note

    A financial instrument that contains a written promise by one party to pay another party a definite sum of money either on ...
  2. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  3. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  4. Absolute Advantage

    The ability of a country, individual, company or region to produce a good or service at a lower cost per unit than the cost ...
  5. Nonce

    Nonce is a number added to a hashed block, that, when rehashed, meets the difficulty level restrictions.
  6. Coupon

    The annual interest rate paid on a bond, expressed as a percentage of the face value. It is also referred to as the "coupon ...
Trading Center