Glossary
Municipal bond
A bond issued by a US state, city or other local government, whose interest is often exempt from federal income tax.
A municipal bond, or muni, is debt issued by a US state, city, county, school district or public authority to pay for things like schools, roads, water systems and hospitals. Its main attraction is tax treatment: interest on most munis is exempt from federal income tax, and often from state tax for residents of the issuing state. That makes munis most valuable to investors in higher tax brackets.
Kinds of munis
- General obligation (GO) bonds are backed by the issuer's full taxing power.
- Revenue bonds are repaid from a specific income stream, such as tolls, water fees or airport charges, and depend on that project's success.
- Private activity bonds fund projects with private beneficiaries; interest on some of them can be subject to the alternative minimum tax.
Comparing a muni with a taxable bond
Because muni interest escapes tax, its yield is compared with a taxable bond's using the tax-equivalent yield.
What to watch for
Defaults among rated munis have historically been rare, but they happen, especially in revenue bonds for single projects, and notable cases such as Detroit and Puerto Rico produced large losses. Many munis are callable and trade infrequently, so prices can be hard to judge. Trade prices and official disclosure documents are free on the MSRB's EMMA site. Holding munis in an IRA wastes their tax advantage, because the account is already sheltered.