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. A municipal bond is a debt obligation issued by a nonprofit organization , a private-sector corporation or another public entity using the loan for public projects such as constructing schools, hospitals and highways.
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 occupancy or other taxes.
When a municipality is a conduit issuer of bonds, a third party covers interest and principal payments. 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 prices decline; when interest rates decline, bond prices rise. 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. Accessed April 10, Municipal Bonds. Fixed Income Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.
In addition, municipal borrowers sometimes issue bonds on behalf of private entities such as non-profit colleges or hospitals. In cases where the conduit borrower fails to make a payment, the issuer usually is not required to pay the bondholders. Get access to:. Note that many issuers maintain websites or webpages specifically for investors in their municipal bonds.
Some issuers hyperlink to those webpages from their homepage on EMMA. Learn how to find issuer homepages on EMMA. The MSRB is a self-regulatory organization whose mission is to protect investors, state and local governments and other municipal entities, and the public interest by promoting a fair and efficient municipal securities market. Use their Contact Form. As with any investment, investing in municipal bonds entails risk.
Investors in municipal bonds face a number of risks, specifically including:. Call risk. Call risk refers to the potential for an issuer to repay a bond before its maturity date, something that an issuer may do if interest rates decline -- much as a homeowner might refinance a mortgage loan to benefit from lower interest rates. Bond calls are less likely when interest rates are stable or moving higher.
Credit risk. Credit ratings are available for many bonds. Credit ratings seek to estimate the relative credit risk of a bond as compared with other bonds, although a high rating does not reflect a prediction that the bond has no chance of defaulting. Interest rate risk. Measure content performance.
Develop and improve products. List of Partners vendors. If your primary investing objective is to preserve capital while generating a tax-free income stream, municipal bonds are worth considering. Municipal bonds munis are debt obligations issued by government entities.
When you buy a municipal bond, you are loaning money to the issuer in exchange for a set number of interest payments over a predetermined period. At the end of that period, the bond reaches its maturity date , and the full amount of your original investment is returned to you. While municipal bonds are available in both taxable and tax-exempt formats, the tax-exempt bonds tend to get the most attention because the income they generate is, for most investors, exempt from federal and, in many cases, state and local income taxes.
Investors subject to the alternative minimum tax AMT must include interest income from certain munis when calculating the tax and should consult a tax professional prior to investing. Municipal bonds come in the following two varieties:.
General obligation bonds , issued to raise immediate capital to cover expenses, are supported by the taxing power of the issuer. Revenue bonds, which are issued to fund infrastructure projects, are supported by the income generated by those projects. Both types of bonds are tax-exempt and particularly attractive to risk-averse investors due to the high likelihood that the issuers will repay their debts.
Although buying municipal bonds is low-risk, they are not entirely without risk. If the issuer is unable to meet its financial obligations, it may fail to make scheduled interest payments or be unable to repay the principal upon maturity. Bonds rated 'BBB', 'Baa', or better are generally considered appropriate investments when capital preservation is the primary objective.
To reduce investor concern, many municipal bonds are backed by insurance policies guaranteeing repayment in the event of default. Every year, Moody's Investors Service publishes "U. Municipal Bond Defaults and Recoveries," a proprietary study on more than 10, municipal bond issuers it covers. The most recent study covers defaults from to Over the past 10 years, the average default rate for investment grade municipal bonds was 0.
Nevertheless, municipal bonds defaults are not uncommon. There were 10 defaults in , seven of which were associated with Puerto Rican debt crisis. The year average default rate for investment grade municipal bonds was 0.
Municipal bonds generate tax-free income and therefore pay lower interest rates than taxable bonds. Investors who anticipate a significant drop in their marginal income-tax rate may be better served by the higher yield available from taxable bonds. Many bonds allow the issuer to repay all or a portion of the bond prior to the maturity date. The investor's capital is returned with a premium added in exchange for the early debt retirement.
While you get your entire initial investment plus some back if the bond is called, your income stream ends earlier than expected. The interest rate of most municipal bonds is paid at a fixed rate. This rate doesn't change over the life of the bond. However, the underlying price of a particular bond will fluctuate in the secondary market due to market conditions. Changes in interest rates and interest rate expectations are generally the primary factors involved in municipal bond secondary market prices.
When interest rates fall, newly issued bonds will pay a lower yield than existing issues, which makes the older bonds more attractive.
Investors who want the higher yield may be willing to pay more to get it. Likewise, if interest rates rise, newly issued bonds will pay a higher yield than existing issues.
Investors who buy the older issues are likely to do so only if they get them at a discount. If you buy a bond and hold it until maturity, market risk is not a factor because your principal investment will be returned in full at maturity. Should you choose to sell prior to the maturity date, your gain or loss will be dictated by market conditions, and the appropriate tax consequences for capital gains or losses will apply. The most basic strategy for investing in municipal bonds is to purchase a bond with an attractive interest rate, or yield, and hold the bond until it matures.
The next level of sophistication involves the creation of a municipal bond ladder.
0コメント