How to Compare Municipal Bonds

Standard and Poor's, Fitch and Moodys rate bonds.

According to Investopedia, municipal bonds have two general types: general obligation bonds and revenue bonds. When comparing municipal bonds, an investor needs to understand that the taxing authority backs the general obligation bonds, whereas the revenue of a project will back revenue bonds.

Identification

The function of comparison begins with the bond's rating whether the bond has a AAA rating (highest) or a C rating (lowest or junk status). This rating comes from the bond rating agencies, which include Standard and Poor's, Fitch, and Moodys. The investor should compare bonds with similar ratings.

Types

Several different categories will become relevant in examining different municipal bonds, which include maturity date, interest rate risk, default risk, liquidity risk and the risk of downgrades by rating agencies.

Warning

An potential investor into municipal bonds needs to compare these bonds with other corporate and government bonds via the tax-equivalent yield. According to Investopedia, the tax-equivalent yield means the before-tax yield that a taxable bond--which includes corporate and government bonds--needs to obtain to be equal to the tax-free yield of a municipal bond. If the corporate or government bond has a higher tax-equivalent yield, the investor should buy this bond and pay the taxes on the interest.

Considerations

The short-term interest rate environment can cause the daily price of the bonds to fluctuate, but at maturity the bondholder will receive the face value of the bond regardless of the interest rate environment.

References

• Investopedia: Basics of Municipal Bonds
• Investopedia: Tax-equivalent Yield