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Fixed Income Securities (Bonds): Municipal Bonds

What Is a Municipal Bond?

Municipal bonds are bonds issues by city or state governments, usually to fund either cover government expenses, or public improvement projects and infrastructure, such as schools, water systems, etc. Interest earned on most municipal bonds is exempt from federal taxes and state taxes within the state of issue.

There are two types of municipal bonds: revenue bonds, and general obligation bonds. General obligation bonds raise money to cover the issuer's expenses. The government pays the interest on the bonds from tax income it generates from citizens. Revenue bonds raise money for public infrastructure projects, either new endeavors or improvements for existing ones. The government pays the interest on those bonds from the income generated by the infrastructure projects.

Municipal bonds are low-risk investments, but governments can default on them if they are unable to pay interest or principal, though this is not common. The general ability of municipal governments to back municipal bonds make them stable investments, with low interest. Furthermore, municipal bonds generally hold a tax-advantaged status, which is another reason for their low interest rate. Holders of municipal bonds do not pay federal income tax on their interest payments; they also do not pay state taxes on the interest if they live in the state where the bond was issued. 


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