Do you know what a bond is?

A bond can be defined as an organization’s IOU; which basically means a promissory note issued that offers to pay you later at a certain fixed rate of interest over a definite period of time. Issuing of bonds is thus a debt collecting measure. Other similar debt collecting instruments are notes and debentures. The maximum numbers of bonds issued today have a fixed rate of interest though variable rate bonds are also coming in vogue.

Corporations issue bonds in order to raise a large sum of money quickly. The money raised may be used for diverse activities like building new offices, purchasing latest equipment etc. Government bonds may be issued when the government needs money for constructing roads, schools, hospitals, etc. for building the infrastructure of the country.

What exactly is a municipal bond?

In the United States, a city or local government issues bonds from time to time and this is known as A Municipal Bond (or muni). In the U.S Municipal Bonds can be issued by cities, counties, school districts, redevelopment agencies, and publicly owned airports, as well as seaports and all other government bodies below the state level.

These bonds are guaranteed by either the local government or a subdivision of the local government or a group of local government. These Municipal Bonds are appraised for risks and are rated accordingly.

Most of the times the income generated by the Municipal Bond by a bondholder is non-taxable. The income generated from Municipal Bond is exempt from Federal Income Tax and State Income tax in the state that issues them. But there are other bonds that may be taxable.

However one has to keep in mind the fact that bonds issued by cities, states, and other local agencies of the government are not as reliable as corporate bonds. Whereas some Municipal bonds that are issued are supported by the taxing authority of the town or the state as the case may be others are supported the earning income to pay the interest as well as the principal. However since Municipal Bonds are not taxable by the federal government they have to pay very little interest compared to corporate bonds.

People find investing in Municipal bonds (also known as “munis”) remunerative because the income is exempt from federal income tax and sometimes also from state and local taxes. Apart from this, you also have the satisfaction of knowing that you are contributing to building the infrastructure of your state and city, which includes funds for welfare of the general mass in building hospitals, schools, highways and other public undertakings.

Two kinds of Municipal Bonds

Generally, Municipal Bonds are of two kinds: general obligation bonds and revenue bonds. The first kind, i.e., General obligation bonds, is issued to cover immediate expenses and are backed by the taxing power of the person issuing it. The second kind of bond that is, Revenue bonds are issued to generate income for future projects for building infrastructure. Both kinds of Municipal Bonds are exempt from state and federal taxes. This makes them attractive to investors who are prone to avoiding high-risk ventures.