What Are Muni Bonds?
Municipal bonds (or muni bonds) are issued by local governmental entities other than the United States Federal government. They are considered creditworthy and provide tax-advantaged income for investors. They are readily available through managed bond funds, managed mutual funds, exchange traded funds or through registered dealers.
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General Obligation Municipal Bonds
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Municipal bonds issued and guaranteed by state and local governments are called general obligation bonds. They carry the full faith and credit of the issuing municipality.
Municipal Revenue Bonds
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Municipal bonds issued and guaranteed only by a specific revenue stream such as water and sewer bonds are called revenue bonds. There is no broad municipal guarantee other than cash flow. Revenue bonds are also issued under a municipal authority for transit, hospital, tax revenue and industrial revenue purposes.
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Tax Exempt Income
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Municipal bonds are exempt from federal income tax. State law determines whether bonds may be free of state taxes for residents of that state. Under local law, municipal bonds may be exempt from city and local tax levies. Bonds issued in one state are not exempt from state taxes by residents in another state.
Taxable Occurences for Municipal Bonds
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Municipal bonds issued at a discount accrue the discount over the life of the bond as tax-free income. Municipal bonds purchased in the open market accrue interest net of any original discount as taxable income. Municipal bonds guaranteed by entities other than state and local governments may be preferable items that subject the owner to alternative minimum tax.
Creditworthiness
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Municipal bonds are historically safe investments, ranking just below United States treasury issues. Default rates for revenue bonds are higher than those of general obligation bonds but significantly above corporate bonds.
Credit Rating
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Moody's, Standard and Poor's and Fitch are the primary credit rating agencies for municipal bonds. They use a credit rating system of letter grades ranging from AAA (the highest rating) to C (default).
Maturity and Coupon Structure
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Municipal bonds are issued for the reasonable life of the project using level debt payments. Bonds are issued for each year of the project, which may run for up to 30 years. Interest is paid on a semiannual basis.
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