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In the United States, a municipal bond (or muni) is a bond issued by a state, city or other local government, or their agencies. Potential issuers of municipal bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds may be general obligations of the issuer or secured by specified revenues. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt. For alternative meanings, see bond (a disambiguation page). ... School districts are a form of special-purpose district in the United States (amongst some other places) which serves to operate the local public primary and secondary schools. ... Tax advantage refers to the economic bonus which applies to certain accounts or investments that are, by statute, tax-reduced, tax-deferred, or tax-free. ... Tax rates around the world Tax revenue as % of GDP Economic policy Monetary policy Central bank   Money supply Fiscal policy Spending   Deficit   Debt Trade policy Tariff   Trade agreement Finance Financial market Financial market participants Corporate   Personal Public   Banking   Regulation        An income tax is a tax levied on the financial income...

Purpose of municipal bonds

Municipal bond issuers

Municipal bonds are issued by states, cities, and countries, or their agencies (the municipal issuer) to raise funds. The methods and practices of issuing debt are governed by an extensive system of laws and regulations, which vary by state. Bonds bear interest at either a fixed or variable rate of interest.

The issuer of a municipal bond receives a cash payment at the time of issuance in exchange for a promise to repay the investors who provide the cash payment (the bond holder) over time. Repayment periods can be as short as a few months (although this is rare) to 20, 30, or 40 years, or even longer.

The issuer typically uses proceeds from a bond sale to pay for capital projects or for other purposes it cannot or does not desire to pay for immediately with funds on hand. Tax regulations governing municipal bonds generally require all money raised by a bond sale to be spent on one-time capital projects within three to five years of issuance.^[1] Certain exceptions permit the issuance of bonds to fund other items, including ongoing operations and maintenance expenses, the purchase of single-family and multi-family mortgages, and the funding of student loans, among many other things.

Because of the special tax-exempt status of most municipal bonds, investors usually accept lower interest payments than on other types of borrowing (assuming comparable risk). This makes the issuance of bonds an attractive source of financing to many municipal entities, as the borrowing rate available in the open market is frequently lower than what is available through other borrowing channels.

Municipal bonds are one of several ways states, cities and counties can issue debt. Other mechanisms include certificates of participation and lease-buyback agreements. While these methods of borrowing differ in legal structure, they are similar to the municipal bonds described in this article.

Municipal bond holders

Municipal bond holders may purchase bonds either directly from the issuer at the time of issuance (on the primary market), or from other bond holders at some time after issuance (on the secondary market). In exchange for an upfront investment of capital, the bond holder receives payments over time composed of interest on the invested principal, and a return of the invested principal itself (see bond). The primary is that part of the capital markets that deals with the issuance of new securities. ... The secondary market is the financial market for trading of securities that have already been issued in an initial private or public offering. ... For alternative meanings, see bond (a disambiguation page). ...

Repayment schedules differ with the type of bond issued. Municipal bonds typically pay interest semi-annually. Shorter term bonds generally pay interest only until maturity; longer term bonds generally are amortized through annual principal payments. Longer and shorter term bonds are often combined together in a single issue that requires the issuer to make approximately level annual payments of interest and principal. Certain bonds, known as zero coupon or capital appreciation bonds, accrue interest until maturity at which time both interest and principal become due.

Municipal bond issued in 1929 by town Kraków (Poland)

For other uses, see Krakow (disambiguation). ...

Characteristics of municipal bonds

Taxability

One of the primary reasons municipal bonds are considered separately from other types of bonds is their special ability to provide tax-exempt income. Interest paid by the issuer to bond holders is often exempt from all federal taxes, as well as state or local taxes depending on the state in which the issuer is located, subject to certain restrictions. Bonds issued for certain purposes are subject to the alternative minimum tax.

The type of project or projects that are funded by a bond affects the taxability of income received on the bonds held by bond holders. Interest earnings on bonds that fund projects that are constructed for the public good are generally exempt from federal income tax, while interest earnings on bonds issued to fund projects partly or wholly benefiting only private parties, sometimes referred to as private activity bonds, may be subject to federal income tax.

The laws governing the taxability of municipal bond income are complex; however, bonds are typically certified by a law firm as either tax-exempt (federal and/or state income tax) or taxable before they are offered to the market. Purchasers of municipal bonds should be aware that not all municipal bonds are tax-exempt.

Risk

Main article: credit risk Credit risk is the risk of loss due to a debtors non-payment of a loan or other line of credit (either the principal or interest (coupon) or both). ...

The risk ("security") of a municipal bond is a measure of how likely the issuer is to make all payments, on time and in full, as promised in the agreement between the issuer and bond holder (the "bond documents"). Different types of bonds carry different securities, based on the promises made in the bond documents:

• General obligation bonds promise to repay based on the full faith and credit of the issuer; these bonds are typically considered the most secure type of municipal bond, and therefore carry the lowest interest rate.
• Revenue bonds promise repayment from a specified stream of future income, such as income generated by a water utility from payments by customers.
• Assessment bonds promise repayment based on property tax assessments of properties located within the issuer's boundaries.

In addition, there are several other types of municipal bonds with different promises of security. A revenue bond is a special type of municipal bond distinguished by its guarantee of repayment solely from revenues generated by a specified revenue-generating entity associated with the purpose of the bonds. ... Property tax, millage tax is an ad valorem tax that an owner of real estate or other property pays on the value of the property being taxed. ...

The probability of repayment as promised is often determined by an independent reviewer, or "rating agency". The three main rating agencies for municipal bonds in the United States are Standard & Poor's, Moody's, and Fitch. These agencies can be hired by the issuer to assign a bond rating, which is valuable information to potential bond holders that helps sell bonds on the primary market. A credit rating agency is a company that rates the ability of a person or company to pay back a loan. ... Publications Standard & Poors publishes a weekly (48 times a year) stock market analysis newsletter called The Outlook, which is issued both in print and online to subscribers. ... Moodys Corporation (NYSE: MCO) is the holding company for Moodys Investors Service which performs financial research and analysis on commercial and government entities. ... Fitch Ratings, Ltd. ... In investment, the credit rating assesses the credit worthiness of a corporations debt issues. ... The primary is that part of the capital markets that deals with the issuance of new securities. ...

Comparison to corporate bonds

Because municipal bonds are most often tax-exempt, comparing the coupon rates of municipal bonds to corporate or other taxable bonds can be misleading. Taxes reduce the net income on taxable bonds, meaning that a tax-exempt municipal bond has a higher after-tax yield than a corporate bond with the same coupon rate. In finance, coupons are attached to bonds, either physically, as with old bonds (with a stapler), or electronically. ... Yield may mean: In economics, yield is a measure of the amount of income an investment generates over time (related to return on investment). ...

This relationship can be demonstrated mathematically, as follows:

where

• r_m = interest rate of municipal bond
• r_c = interest rate of comparable corporate bond
• t = tax rate

For example if r_c = 10% and t = 38%, then

A municipal bond that pays 6.2% therefore generates equal interest income after taxes as a corporate bond that pays 10% (assuming all else is equal).

Alternatively, one can calculate the taxable equivalent yield of a municipal bond and compare it to the yield of a corporate bond as follows:

Because longer maturity municipal bonds tend to offer significantly higher after-tax yields than corporate bonds with the same credit rating and maturity, investors in higher tax brackets may be motivated to arbitrage municipal bonds against corporate bonds using a strategy called municipal bond arbitrage. Yield may mean: In economics, yield is a measure of the amount of income an investment generates over time (related to return on investment). ... In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

References

External links

• MSRB's EMMA Education Center
• Detailed Overview of Municipal Bonds,
• The Bond Buyer, newspaper focusing on the municipal bond industry.
• Securities Industry and Financial Markets Association, the industry trade group.
• Municipal Finance Journal, the only peer-reviewed journal devoted to municipal securities and state & local public finance.
• About Municipal Bonds
• Prospect News Municipals Daily, Market focused news for professionals