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Municipal Bond Definition

By James Chen
4-5 minutes

What Is a Municipal Bond?

A municipal bond is a debt security issued by a

state, municipality or county to finance its capital
expenditures, including the construction of
highways, bridges or schools. They can be
thought of as loans that investors make to local
governments. Municipal bonds are exempt from
federal taxes and most state and local taxes,
making them especially attractive to people in
high income tax brackets.
Municipal bonds may also be known as "muni
bonds" or "muni.".

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Key Takeaways

Municipal bonds ("munis") are debt securities

issued by state and local governments.
These can be thought of as loans that investors
make to local governments, and are used to fund
public works such as parks, libraries, bridges &
roads, and other infrastructure.
Interest paid on municipal bonds is often tax-free,
making them an attractive investment option for
individuals in high tax brackets.
General obligation (GO) munis return cash flows
generated from the project itself (e.g. a toll road),
while revenue munis provide cash flows
generated from collected taxes.

What Is A Municipal Bond?

Understanding Municipal Bonds

A municipal bond is a debt obligation issued by a

nonprofit organization, a private-sector

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corporation or another public entity using the

loan for public projects such as constructing
schools, hospitals and highways.

Types of Municipal Bonds

A municipal bond is categorized based on the

source of its interest payments and principal
repayments. A bond can be structured in different
ways offering various benefits, risks and tax
treatments. Income generated by a municipal
bond may be taxable. For example, a
municipality may issue a bond not qualified for
federal tax exemption, resulting in the generated
income being subject to federal taxes.
A general obligation bond (GO) is issued by
governmental entities and not backed by revenue
from a specific project, such as a toll road. Some
GO bonds are backed by dedicated property
taxes; others are payable from general funds.
A revenue bond secures principal and interest
payments through the issuer or sales, fuel, hotel

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occupancy or other taxes. When a municipality is

a conduit issuer of bonds, a third party covers
interest and principal payments.

$3.8 trillion

In 2018, the municipal bond market constituted

about $3.8 trillion in assets.[cite]

Municipal Bond Risks

Default risk is low for municipal bonds when

compared with corporate bonds. However,
revenue bonds are more vulnerable to changes
in consumer tastes or general economic
downturns than GO bonds. For example, a
facility delivering water, treating sewage or
providing other fundamental services has more
dependable revenue than a park's rentable
shelter area.
As a fixed-income security, the market price of a
municipal bond fluctuates with changes in
interest rates: When interest rates rise, bond

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prices decline; when interest rates decline, bond

prices rise. In addition, a bond with a longer
maturity is more susceptible to interest rate
changes than a bond with a shorter maturity,
causing even greater changes in the municipal
bond investor’s income. Furthermore, the
majority of municipal bonds are illiquid; an
investor needing immediate cash has to sell
other securities instead.
Many municipal bonds carry call provisions,
allowing the issuer to redeem the bond prior to
the maturity date. An issuer typically calls a bond
when interest rates drop and reissues municipal
bonds at a lower interest rate. When a bond is
called, investors lose income from interest
payments and face reinvesting in a bond with a
lower return. (For related reading, see "The
Basics of Municipal Bonds")

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