Municipal bonds are bonds issued by municipalities, oftentimes for the purpose of funding infrastructure or other public works projects. One of the major advantages of municipal bonds is that their interest is exempt from federal income tax, making them especially attractive to investors in high tax brackets.
Municipal bonds can be either general obligation bonds or revenue bonds.
Revenue bonds are backed by revenue generating municipal projects including stadiums, toll roads, and transit projects such as New York State’s Metropolitan Transit Authority. Because they are not backed by the full faith and credit of the issuer, these bonds are typically riskier and subsequently pay a higher coupon than general obligation bonds.
General obligation bonds are backed by the full faith and credit of the municipality issuing the bonds and are serviced using general municipal government revenue including income taxes and property taxes. General obligation bonds are typically less risky than revenue bonds and subsequently pay a lower coupon than revenue bonds.
Like all fixed income instruments, municipal bonds have both interest rate risk and credit risk. From a credit risk standpoint, municipal bonds tend to be slightly riskier than sovereign bonds and slightly less risky than corporate bonds, although this is not always the case. As with other fixed income instruments, the interest rate risk of a municipal bond increases as the duration of the bond increases.