Municipal Bonds

Municipal bonds are debt securities that states, cities, counties, and other governmental entities issue to raise money for public purposes such as building schools, highways, hospitals, sewer systems, and other special projects. A primary feature of many municipal securities is that the interest you receive is generally exempt from federal income tax. The interest may also be exempt from state and local taxes if you live in the state where the bond is issued.

When you purchase a municipal bond, you lend money to the "issuer," the government entity that issued the bond. In exchange, the government entity promises to pay you a specified amount of interest, usually semiannually, and return your money, also known as "principal," on a specified maturity date.

There are two types of municipal bonds. The first is called a general obligation bond and is backed by the issuer's ability to tax. This type of bond is generally used for large capital projects such as schools, highways and other special projects.

Revenue municipal bonds are issued by special state or local-government sanctioned entities, such as a utility company. The interest is paid by the revenue generated from the business that backs the obligation. In the case of a utility company, bond holders are paid out of the cash generated from customers paying their utility bills.

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