A municipal bond is a debt security that has been issued by a local government entity. Examples of these issuers are state, county and city governments. Municipal bonds are commonly used to fund the construction of roads, schools, airports, hospitals, wastewater treatment facilities and other infrastructure projects. The interest income that an investor receives from a municipal bond is exempt from federal taxation and may also be exempt from taxation at lower levels of government. This tax exemption makes municipal bonds an especially attractive investment for individuals with a high incremental tax rate. However, smaller investors tend to be excluded from this market because most of these bonds are issued in minimum denominations of $5,000.
The most common types of municipal bonds are:
- General obligation bond. This type of bond is backed by the general funds of the issuer.
- Revenue bond. This type of bond is backed by the revenue raised from specific sources. Depending on the revenue source, this type of municipal bond can be a riskier investment.
The market price of a municipal bond will vary with changes in the market interest rate. As the market rate increases, the value of a municipal bond will decline. Conversely, if the market rate declines, the value of a municipal bond will increase.