What are municipal bond?
A municipal bond, or “muni,” is a debt instrument used by local and state governments to raise money for public projects.
How it works
Municipal bonds are basically a loan from investors to the government.
When a government needs to raise funds to pay for a big project, selling bonds to investors enables it to raise a lot of money quickly and then pay it back later.
Types of municipal bonds
There are two types of municipal bonds. The primary difference is how the bond investors are repaid.
Revenue Bond vs General Obligation (GO) Bond
|Item||Revenue Bond||General Obligation (GO) Bond|
|Source||Investors are repaid with revenue from the specific project the bond capital funded.||Investors are repaid from any available government funds.|
|Examples||Toll revenue from new bridges or roads, Sales revenue from a new stadium||Property taxes, General funds, Income from such projects as toll roads|
Municipal bonds can be used to generate funds for any project that will benefit the public.
Common public projects include the construction of:
- Roads and highways
- Low Risk—Backed by governments, so there is less risk of default
- GO municipal bonds are even less risky than revenue bonds because the government can use any type of fund to repay bondholders.
- Remember that no investment is entirely risk free.
- Tax Free—Interest income from municipal bonds is often but not always exempt from local, state, and sometimes even federal taxation
- The taxable status of a municipal bond may depend on the type of bond and whether or not you live in the state or city that issued it.
Terms to know
- Par Value: The face value of the bond; how much the investor will be repaid when the bond matures.
- Purchase Price: The amount an investor pays for the bond; may be more or less than the Par Value depending on investor demand, bond risk, and maturity date.
- Maturity Date: The date on which the issuing government must repay bondholders; most municipal bonds take 20–30 years to mature.
- Coupon Rate: The rate of interest the bond pays as a function of its par value.
- Example: A bond with a par value of $5,000 with a coupon rate of 5% would pay $250 in interest annually regardless of its purchase price.
- The first municipal bond was issued in 1812, long before corporate bonds were introduced.
- In 2016, state and local governments issued a whopping $445.8 billion in municipal bonds.