Tuesday, March 26, 2013

What is a Municipal Bond

A Municipal Bond (or muni) is a bond issued by a city or local government in the United States. Some of the bodies that can issue Municipal Bonds include cities, counties, redevelopment agencies, school districts, publicly owned airports and seaports and any other governmental entity below the state level.

Guarantee for Municipal Bonds is provided by the local government, a subdivision of the local government, or a group of local governments. All Municipal Bonds are pre-assessed for risk and are given an appropriate rating.

In most cases, the income generated by a Municipal Bond holder by the interest on the bonds is exempt from both the Federal Income Tax and the State Income Tax (for the state in which the bonds were issued). There can be exceptions to this and certain bonds could be declared taxable.

Whether the income received by bondholders through the interest on the bonds is taxable depends largely on the type of projects that are funded by that bond. For instance, if the bonds were issued to gather money for a construction that is meant for the welfare of the public, those bonds are not likely to be taxed. On the other hand, if the bonds are used for a project that would only benefit a handful of private parties, then the federal or state taxes might be applicable.

The laws for determining which bonds are to be taxed and which are not are very complicated. The taxable status of every bond is fixed before it reaches the market. If you are a regular buyer of Municipal Bonds then you should know that not all of them are tax-exempt.

The risk (or security) associated with a Municipal Bond is determined on the basis of the ability of the issuing body to make all payments on time and in full, as pledged in the agreement between the issuer and the bond holder. Different bonds have different types of securities based on the commitments that are formally documented in the bonds.

Some of these are:

* General Obligation Bonds - These assure that the bond value will be repaid on full faith and credit of the issuer. These bonds are supposed to be the most secure Municipal Bonds and carry the lowest interest rates.

* Revenue Bonds -These assure that the bond value will be repaid from a stream of future income once the project is complete. Toll payments are frequently used to pay for such projects. These Municipal Bonds are slightly risky because they rely on the success and profitability of the project. They do carry a slightly higher interest rate.

* Assessment Bonds - These assure that the bond value will be repaid based on the property tax assessments of the properties located within the issuer's boundaries.

There are rating agencies used for the purpose of determining the probability of repayment as is assured by the bond issuer before the bonds are issued.

Standard & Poor's, Moody's, and Fitch are the three top rating agencies for Municipal Bonds in the United States. Any bond issuer can sign up with these agencies to get a bond rating.
Bond buyers must pay close attention to the rating before purchasing any bonds.

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