What are municipal bonds ?
Municipal bonds (or “munis” ) are debt securities issued by states, cities and other governmental entities to finance capital projects such as building schools, highways or sewer systems. By purchasing municipal bonds, you are in effect lending money to the bond issuer in exchange for a promise of regular interest payments. Usually, the interest on municipal bonds is exempt from federal income tax. If you reside in the state where the bond is issued, the interest may also be exempt from state and local taxes. These bonds can be categorized in the following two categories :
- General obligation bonds are issued by states, cities or counties and not secured by any assets. Instead, general obligation are backed by the “full faith and credit” of the issuer, which has the power to tax residents to pay bondholders.
- Revenue bonds are not backed by government’s taxing power but by revenues from a specific project or source, such as highway tolls or lease fees. Some revenue bonds are “non-recourse”, meaning that if the revenue stream dries up, the bondholders do not have a claim on the underlying revenue source.