municipal bond (muni)

In the USA, a municipal bond is a bond issued by a state, city or other local government, or their agencies. In finance, a bond is a debt security, where the issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon). Munis often represent investments in projects that have an impact on our daily lives, including schools, highways, hospitals, housing, sewer systems and other important public projects. These bonds offer a municipality the opportunity to raise funds without directly raising taxes. Potential issuers of municipal bonds include cities, redevelopment agencies, counties, school districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds are guaranteed by local government or a group of local governments, and assessed for risk and rated accordingly. Interest income received by holders of municipal bonds is exempt from federal income tax and income tax of state in which they issued, although municipal bonds issued for certain purposes may not be tax exempt. One of the primary reasons municipal bonds are considered separately from other types of bonds is their special ability to provide tax-exempt income.

Generally, municipal bonds are considered safer than corporate bonds because a local government is far less likely to go bankrupt than a corporation-however, it has happened in the past, so be aware of the possibility. Because of this safety and the tax benefits, municipal bonds generally have a lower yield than corporate bonds. In order to evaluate the merits of a tax-free bond, you will need to calculate the tax-equivalent yield on the bond. This is the amount of interest a tax-free bond would have to provide to create the same return as a taxable bond. Of course, this calculation will depend on the tax bracket of the individual, but it is an effective way to compare the merits of taxable and tax-free bonds. Investors should also be aware some municipal bonds are subject to the Alternative Minimum Tax. The bond type which is most often subject to the AMT is one which involves a private and public partnership for something like a sports stadium.

Some municipal bonds can also be insured by outside agencies. These companies will promise to pay the interest and principal if the issuer defaults. Interestingly, both issuers and bondholders can carry this insurance, though a bondholder would need to have a large stake to get the coverage. Another concern about municipal bonds is the secondary market. In many cases the secondary market is very small, meaning it may be very difficult to sell your bond if you no longer wish to hold it. For more details about the risks that face all bonds, including municipal bonds.
Many investors are often discouraged by the apparently lower yields offered by municipal bond funds when compared to bond funds paying taxable interest dividends. However, if you have to pay federal, state, and/or local taxes on the interest income distributed to you by taxable bond funds, a bond fund that invests in municipal bonds may actually generate more net interest income than a taxable bond fund with a higher stated yield.

Municipal bond funds normally seek to earn income and pay dividends that are expected to be exempt from federal income tax. If a fund investor is resident in the state of issuance of the bonds held by the fund, interest dividends may also be free of state and local income taxes. Such interest dividends may be subject to federal and/or state alternative minimum taxes. Investing in municipal bond funds for the purpose of generating tax-exempt income may not be appropriate for investors in all tax brackets. Fund shareholders may also receive taxable distributions attributable to a fund's sale of municipal bonds. Fund redemptions, including exchanges, may result in a capital gain or loss for federal and/or state income tax purposes.

The bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a debt security to decrease.

Information provided is general and educational in nature. It is not intended to be, and should not be construed as, legal or tax advice. Fidelity does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Consult an attorney or tax advisor regarding your specific legal or tax situation.

You may generate capital gains on a tax-exempt security if you sell it at a profit in the secondary market before it matures. Long-term capital gains (which require a 12-month holding period) resulting from the sale of tax-exempt municipal bonds are taxed at a maximum rate of 15% for all sales on and after May 6, 2003.

Of course, if you sell your security for less than your original purchase price, you may incur a capital loss. Under current law, up to $3,000 of net capital losses can be used annually to reduce ordinary income. Capital losses can be used without limit to reduce capital gains. Special rules apply to a tax-exempt bond purchased at a premium or a discount and called or sold before maturity. (Since tax laws frequently change, consult with your tax lawyer or accountant for up-to-date advice.)

Act of 1911 and 1915
Used for developments within a particular district and are secured by special assessment taxes set at a fixed dollar amount for the life of the bond. 1911 Act Bonds are secured by individual parcels, while 1915 Act Bonds are secured by all properties within the district.

Callable Bond
A bond that can be redeemed by the issuer prior to its maturity. Usually a premium is paid to the bond owner when the bond is called.

Mello Roo's
Bonds used for developments that benefit a particular district (schools, prisons, etc.) and are secured by special taxes based on the assessed value of the properties within the district. Tax assessment is included on the county tax bill.

http://www.emuni.com/ Since 1995, Electronic Municipal Statistics (eMuni) has provided documents, news, developments and financial information relating to the U.S. municipal bond

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