Municipal bonds provide tax exemption from federal taxes and many state and local income taxes, depending on the laws of each state. Newly issued bonds, like stocks, are brought to market with price restrictions until the new issue is sold. Bonds are free to trade at any time once they are purchased by the investor. Professional traders regularly trade the same bonds several times a week.
Municipal Bond Properties
Municipal bonds are private property that is protected by law and the terms of the bond covenant -- the agreement between bond issuer and bond investor. Unlike certificates of deposit, which have principal and interest guaranteed by the issuer, the credit and interest risk that municipal bonds carry rests with the investor. A bond with a long maturity and low credit rating fluctuates in price more than any other bond; such a bond will also carry a higher yield.
Short-term Municipal Notes
Short-term bonds are called notes. Investors may be offered the opportunity to buy intermediate bonds that have short-term repurchase guarantees (called puts) by major financial institutions, such as banks or insurance companies. These guarantees allow the investor, as their right, to resell a longer term note prior to maturity back to the issuer at its maturity value. The ability to resell the note is only as good as the ability of the financial institution to meet its obligations. During the credit crisis of 2008, not all credit guarantees were honored on a timely basis and the value of the note reverted to its value on the open market.
Call features allow the issuer, not the investor, to redeem bonds prior to maturity. The call, also referred to as the extraordinary redemption feature, gives the borrower the right, but not the obligation, to redeem bonds. Long-term bond issuers do not give the investor a similar right, called a put. Instead, the investor must sell a bond into the open market where it is bid on by market professionals at prevailing interest rates. There is no direct control an issuer or governmental body has that refuses the property right of an investor to sell a bond whenever they wish. Rather, high market interest rates may suggest that the investor wait to sell the bond when bond prices are lower. This lessens possible loss of principal.
Selling Municipal Bonds Before Maturity
If an investor decides to sell a municipal bond, tax effects will affect the decision to sell a bond prior to maturity. Selling a bond at a gain or loss must be reported for tax purposes. Many investors employ a tax-saving strategy of selling bonds whenever they are at a loss, and reinvesting the proceeds into a bond with the same or greater yield in order to offset gains in other bonds or stocks. Municipal bond brokers assist customers who seek to employ these tax strategies.