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Municipal bonds are issued by municipalities for immediate funds and to finance specific projects. Most municipal bonds are exempt from federal taxes and from state and local taxes, if the bond was issued by a municipality within the taxpayer's state. Because of the tax exemption, and because of their relative safety, municipal bonds generally pay the lowest interest rates.
Some municipal bonds, when they are not backed by the taxing power of the municipality, are insured. In the event of a default, the insurance company pays the par value of the bond. Insured bonds, because of their lower risk, generally pay a lower interest rate than uninsured bonds.
General obligation bonds are obligations of a government or its agency, and backing for the bond issues from the issuer�s unlimited taxing power. City, county, and school district bonds are particularly safe because they are based upon ad valorem real estate taxes.
Limited and special tax bonds� safety is derived from a specific tax, such as a gasoline tax or a special assessment. These bonds are not quite as secure as GOs, because they are based upon a specific tax; nonetheless, they are generally safe.
Authorities and agencies, created by state governments to perform specific functions, issue bonds for specific needs, such as the construction of a building, that generally have the power to levy fees for their services, such as the operation of water and sewers, or they have contractual arrangements with a government entity that provides payments for services. Revenue bonds are not backed, however, by the taxing power of the government entity.
Industrial revenue bonds finance the construction of a commercial facility for a private user. A local community creates an industrial development authority that can borrow money by issuing municipal bonds. The facility is then leased backed to the corporate guarantor. Though the safety of the bond is dependent on the creditworthiness of the corporation, and not the municipality, frequently, the corporation has superior credit.
Capital appreciation bonds are municipal zero coupon bonds, which are issued at deep discounts to its face value, and pays its interest at maturity by paying the face value of the bond.
Prior to the Tax Reform Act of 1986, almost all municipal bonds were exempt from federal taxes, and from state and local taxes if the bond was issued by the state of the taxpayer. However, the Tax Reform Act of 1986 allowed only public purpose bonds to be tax-exempt, and could be issued in any quantity. These are bonds that are issued to primarily benefit the public. However, if the bond benefits private parties more than 10%�a private purpose bond�then it is generally taxable. Private purpose bonds, also known as alternative minimum tax bonds, or AMT bonds, can be designated as tax-exempt, but there is a volume cap, and the interest paid by these bonds are tax preference items that must be included in calculating the alternative minimum tax.
Because wealthy people are generally subject to the alternative minimum tax, and because they are the main buyers of most municipal bonds, since the tax exemption benefits them the most, they generally shun AMT bonds. This lowers the demand for AMT bonds, which increases the amount of interest they pay compared to other municipal bonds. Thus, AMT bonds are a good investment for people not subject to the alternative minimum tax.
Various short-term notes are issued by municipalities for current income that will be paid off by expected future revenue. Hence, many of these notes are called anticipation notes.
Issued by municipalities to finance current operations. Municipal notes, usually in $25,000 denominations, have maturities that range from 60 days to about a year, when interest and principal are paid by tax or bond revenues.
Tax anticipation notes (TAN)are issued by cities for current income, and are paid off when tax revenues are collected. Bond anticipation notes (BAN) are issued in anticipation of bond revenue that will come later because the municipality wants to combine several projects into 1 bond issue, or because poor market conditions delay the issuance of bonds. Revenue anticipation notes (RAN) are issued in anticipation of revenue from the project that it finances, such as a toll road or a sewer system. Tax and revenue anticipation notes (TRAN) are paid by future taxes and revenue. Grant anticipation notes (GAN) are paid by federal grants, and state aid anticipation notes (SAAN) are paid off by aid received from the state.
Municipal Bonds
Bond Yields, Credit Risk, Taxable Equivalent Yield (TEY)
Special Bonds - Advanced Refunded Bonds, Put Bonds, Convertible Bonds
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