Jan. 28, 2011
Municipal bonds are debt securities issued by states, cities, counties and other governmental entities to finance capital projects, such as building schools, highways or sewer systems, and to fund day-to-day obligations. Investors who buy municipal bonds are in effect lending money to the bond issuer in exchange for a promise of regular interest payments, usually semi-annually, and the return of the original investment, or “principal.” The date when the issuer repays the principal, the bond’s maturity date, may be years in the future. Short-term bonds mature in one to three years, while long-term bonds generally will not mature for more than a decade.
Individual investors hold about two-thirds of the roughly $2.8 trillion of U.S. municipal bonds outstanding, either directly or indirectly through mutual funds and other investments. Bond investors typically are seeking a steady stream of income payments, and compared to stock investors, they may be more risk-averse and more focused on preserving rather than accumulating wealth.
Benefits to investors in municipal bonds include the fact that interest on such bonds generally is exempt from federal income tax and may also be exempt from state and local taxes for residents in the state where the bond is issued. Given the tax benefits, the interest on municipal bonds is usually lower than on taxable fixed-income securities such as corporate bonds.
The two most common types of municipal bonds are general obligation bonds (bonds backed by the “full faith and credit” of the issuer) and revenue bonds (bonds backed by the revenues from a specific project or source). In addition, municipal borrowers sometimes issue bonds on behalf of private entities such as non-profit colleges or hospitals. These “conduit” borrowers typically agree to repay the issuer, who pays the interest and principal on the bonds.
Investors who buy municipal bonds face a number of risks, including: call risk, credit risk, inflation risk, interest rate risk, and liquidity risk. For additional information regarding each of these risks, as well as more information about municipal bonds generally, please review the SEC’s investor bulletin on municipal bonds and "Municipal Securities Information Sources" in our Fast Answers database.
Additional information on municipal bonds is also available at: