Municipal Bonds

Everything But The Kitchen Sink

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.

In exchange for providing project funding, bond investors receive interest payments and the promise of full repayment of the par value of the bond at a specified date.

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

Uses

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
  • Hospitals
  • Bridges
  • Schools
  • Stadiums
  • Libraries

Investor benefits

  • 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.

Fun facts

  • 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.

References

  1. http://www.taxpolicycenter.org/briefing-book/what-are-municipal-bonds-and-how-are-they-used
  2. http://www.investopedia.com/terms/c/coupon-rate.asp
  3. http://www.investopedia.com/ask/answers/111414/how-does-bonds-coupon-interest-rate-affect-its-price.asp
  4. http://www.investopedia.com/ask/answers/050415/what-difference-between-par-value-and-face-value.asp?ad=dirN&qo=investopediaSiteSearch&qsrc=998&o=40186
  5. http://www.investopedia.com/ask/answers/061715/will-price-premium-bond-be-higher-or-lower-its-par-value.asp?ad=dirN&qo=investopediaSiteSearch&qsrc=998&o=40186
  6. http://www.investopedia.com/terms/m/municipalbond.asp
  7. http://www.investopedia.com/terms/r/revenuebond.asp
  8. http://www.investopedia.com/terms/g/generalobligationbond.asp
  9. https://investor.gov/introduction-investing/basics/investment-products/municipal-bonds
  10. http://www.municipalbonds.com/education/the-basics-of-municipal-bonds/
  11. http://www.sifma.org/research/statistics.aspx
  12. http://www.investopedia.com/articles/bonds/05/022805.asp
  13. https://www.thebalance.com/what-are-general-obligation-bonds-and-revenue-bonds-417150
  14. https://www.fool.com/retirement/2017/01/08/5-fascinating-things-you-probably-didnt-know-about.aspx
  15. http://www.naic.org/capital_markets_archive/160419.htm

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