Municipal bond

A municipal bond is a loan an investor makes to a state or local government. The issuer — a state, city, county, school district, or public authority — borrows money to build roads, schools, water systems, and other public projects, and pays the bondholder interest until the principal is repaid at maturity.

Municipal bonds come in two main structures. General obligation (GO) bonds are backed by the issuer's full faith, credit, and taxing power, and typically require voter approval since taxes service the debt. Revenue bonds are repaid only from the income of a specific facility — tolls from a bridge, fees from a water utility — so they carry more risk than GOs from the same issuer and generally offer higher yields.

The defining feature of municipal bonds is their tax treatment. Interest is generally exempt from federal income tax, and most states also exempt interest on bonds issued within their own borders, so an in-state resident can earn interest that is entirely tax-free. Because of this advantage, munis offer lower stated yields than comparable corporate bonds, and they make the most sense for investors in high tax brackets. Comparing a muni to a taxable bond requires computing the tax-equivalent yield: the municipal yield divided by (1 − the investor's tax rate).

Municipal securities appear throughout the securities licensing exams. The Series 6, Series 65, and Series 66 all test the GO-versus-revenue distinction, the tax exemption and tax-equivalent yield math, and suitability — classic exam answers pair municipal bonds with high-bracket investors and flag them as poor choices inside tax-deferred retirement accounts.