About Municipal Bonds
When it comes to investing, there are many choices. In the world of bonds, there are corporate bonds, treasury bonds, and municipal bonds, usually known as muni bonds.
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Significance
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Municipal bonds allow state and local governments and their related entities to raise capital. In issuing municipal bonds, these government groups gain access to capital up front in exchange for paying the money back over time. This allows for large projects to be undertaken without coming up with all the money first. This is important because many large expenditures for governments can come on quickly and may be difficult to save for.
Benefits
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Municipal bonds carry several benefits. First, muni bonds pay interest to the investor. This interest is free from federal taxes. In addition, many state and local governments exempt the interest from their muni bonds from taxes as well, meaning the interest can be completely tax free. Muni bonds are generally considered relatively safe because governments generally operate under both sunshine laws, and without complex or aggressive financing thatcorporations might use.
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Types
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Bonds that provide tax free interest regardless of whether or not someone is subject to the AMT are called non-preference bonds. These bonds must be used for specific government purposes, whereas preference bonds can be used for things like improvement districts. Bonds that are backed by the full faith and credit of the government entity are called General Obligation bonds and are paid back with any and all revenues. This is in contrast to Revenue Bonds, which are only backed by the revenues of a certain entity such as an airport.
Size
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Municipal bonds are generally sold in increments of $1,000 with $1,000 being the face value of the bond. In the case of zero coupon bonds, the issue price will actually be lower, but the bond will redeem at maturity for $1,000. Interest rates on muni bonds tend to be higher than treasuries which are considered safer, but lower than corporate bonds which have no tax advantages.
Geography
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Not surprisingly, large states like California and Texas issue more municipal bonds than smaller states. In addition, California muni bonds tend to have lower interest rates for similarly rated bonds from other states because higher state income taxes make the tax free interest more compelling. In Texas, similarly rated muni bonds have higher interest rates because Texas has no state income tax, so there is no tax advantage to hold Texas muni bonds versus other state muni bonds.
Warning
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As with all investments, muni bonds can and do lose market value due to fluctuations in interest rates, supply and demand, and other factors. Although defaults on state level general obligation bonds are rare, it is possible. Muni bonds from smaller entities are often unrated, which means that they have not been examined and assigned a rating by a rating firm.
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