Municipal bonds are issued by state or local governments in the US to raise money. General obligation bonds and revenue bonds are the two main types, with general obligation bonds being backed by the government’s ability to pay its debts. They can be purchased from a licensed securities dealer or through a mutual fund, and are typically low-risk investments. Interest income is exempt from federal income tax, and sometimes state and local taxes. Credit ratings can help determine the risk level of a particular bond.
In the United States, municipal bonds are debt securities issued by state or local governments, called municipalities, to raise money. General obligation bonds and revenue bonds are the two main types of municipal bonds. Revenue bonds are sold to finance specific government projects. General obligation bonds are issued to raise money for a variety of needs, such as bridges, highways, and schools.
State and local governments generally sell general obligation bonds at set times, called hours. These bonds are backed only by the government’s ability to pay its debts. The government is called the issuer of bonds, and the buyer is called the bondholder. The purchase price is called face value or par value. General obligation bonds are long-term bonds that have maturity dates greater than one year.
General obligation bonds are sold at a fixed interest rate called the coupon rate. Regular interest payments are made to the bondholder until the maturity date. At maturity, the issuer returns the face value to the bondholder. Sometimes the interest and face value are returned to the investor at maturity in a lump sum. This type of bond is called a zero coupon bond.
A primary benefit of purchasing municipal bonds is that the interest income is exempt from federal income tax. If a person buys a municipal bond issued in the state in which he lives, the interest income may also be exempt from state and local taxes. Because interest income may be tax-exempt, general obligation bonds generally pay lower interest rates than other debt securities.
General obligation bonds can be purchased from a licensed securities dealer or through a mutual fund that invests in municipal bonds. Mutual funds help further reduce risk by including a variety of bonds from different issuers. In general, it is easier for an individual to purchase bonds through a mutual fund. The mutual fund dealer and manager may collect investor commissions and management fees when bonds are purchased.
Municipal bonds are typically low-risk investments compared to corporate bonds or the stock market. Governments can raise taxes or take money from other sources of revenue to pay interest and face value owed to bondholders. It is still possible for a state or local government to default on the bonds, causing investors to lose money.
To help determine the risk level of a particular general obligation bond, investors can check the bond’s credit ratings. Companies that supply these ratings include Standard & Poor’s (S&P), Fitch Ratings, and Moody’s. Bond credit ratings are generally provided at no cost to the investor.
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