Bond issuers - Municipals

This is an introductory page in fixed income. If you are unfamiliar with any of the terms, you can refer to the Fixed Income Glossary.

A municipal bond (munis) is issued by state and local governments, on the basis of their taxing power or anticipated revenue. Munis are exempt from federal taxes, and may also be exempt from state and local taxes. As such, investors buy munis for the tax advantages, and thus yields on munis can be lower than other equivalent taxable bonds.

There are two types of munis based on how the interest is paid:

• General obligation bonds: The principal and interest are based on the full faith and credit of the issuer, and is usually supported by its taxing power. Typically, general obligation bonds are voter-approved.
• Revenue bonds: The principal and interest are secured by revenues derived from tolls, charges, or rents from the facility/service that is built with the proceeds of the bond. This allows public projects like infrastructure, transportation, housing, medical case, etc. to be built.

Similar (but not identical) to the Treasuries, short term municipal securities are called notes and mature in a year or less, while long term municipal securities are called bonds and mature over a longer period.

Since munis can provide tax-exempt income, they need to be considered separately from other types of bonds. If interest on a bond is exempt from $T \%$ of tax, then the taxable-equivalent yield of a muni is

$$\text{Taxable Equivalent Yield} = \frac{ \text{Municipal Yield} } { 100\% - T \% }.$$

Note that the value of $T$ depends on the individual. Those in the highest income tax bracket would thus have the most to gain, while those who do not earn enough to pay income tax will not benefit much from the tax-exemption.