What is a municipal bond?

Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities, which use the money to build schools, highways, hospitals, sewer systems, and many other projects.

When you purchase a municipal bond, you are lending money to a state or local government entity, which in turn promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date.  Most municipal bonds can be redeemed prior to maturity.  This is a date specified in the “Offering Statement” and is known as the “Call Date.”

Not all municipal bonds offer income exempt from both federal and state taxes.  Most states exempt the interest paid by municipal bonds issued by entities within that state but tax interest earned on bonds from other states.  There is an entirely separate market of municipal issues that are taxable at the federal level, but still offer a state—and often local—tax exemption on interest paid to residents of the state of issuance.

Municipal bonds are issued in denominations of $5000.  Most investors in municipal bonds buy them on the secondarily market.  The actual price paid for a bond may be either more or less than “par” which is defined as 100 cents on the dollar.  The stated interest on a bond is referred to as the “coupon” rate.  Bonds are priced so that bonds of equal quality with the same maturity (or call) date have the same yield to maturity.

The municipal bond market is a specialized market and requires an in-depth knowledge of issuers, quality, yields and prices.