Wednesday, September 10, 2008

Municipal Bond Characteristics

As part of my Series 6 studies, I've found the need to review the characteristics of the municipal bond. I thought that this could be an area where others could benefit from this quick review as well.

Municipal bonds are debt securities issued by state and local governments to finance public projects by local governments to finance public projects such as construction. They can be classified as either GO Bonds or as Revenue Bonds.

GO Bonds, also known as General Obligation Bonds, are considered low risk because the bond is backed by the taxing power of the government. Revenue Bonds are issued to finance projects that will generate income which will be used to re-pay the bonds. Revenue bonds are considered riskier because there are no taxes backing payment. If a project is unable to generate sufficient revenue, then the bonds can go into default.

The primary advantage to having municipal bonds is their tax status. Interest income earned on these bonds are generally tax free at the federal level. For investors that live within the state or municipality issuing the bond, the interest income is also potentially tax free at the local level. This is partially because municipalities would like to give an incentive to the citizens to support local government construction and infrastructure efforts. These tax advantages can be especially interesting for those in a high tax bracket because the earnings generated may be tax free.

There is a special kind of revenue bond that deserves a little more description because it does not have this tax advantage. Industrial Development Bonds can be issued to finance projects that will be leased to an outside company. The lease payments are used to re-pay the bond. Since the facilities are used by private industry, interest income on these bonds is taxable by the federal government.

Hopefully this review about municipal bond characteristics has been useful. If this topic interests you, feel free to drop me a comment. Thanks.

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