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What are Municipal Bonds?

Definition: The municipal bonds, also known as munis or muni bonds, are highly liquid debt securities issued by a municipality or local government to raise funds for a capital investment or infrastructure project.

What Does Municipal Bonds Mean?

What is the definition of municipal bonds? Muni bonds are provided to collect money for various community projects. For example, the municipality may issue municipal bonds for a par value of $100 million and offer investors an annual interest rate of 5%. In doing so, the state can build public buildings at a lower cost. By printing muni bonds, the municipality or the governor can finance the construction of bridges, airports, ports, subways, roads and highways, hospitals, public housing systems, sewerage and water supply, energy companies and various public works.

Letís look at an example.

Example

Muni bonds are classified into state, national, insured, and high-yield munis. All four categories are exempted from federal income taxes, and, in some cases, they may also be exempted from state and local taxes. Therefore, they can be a great source of income by incurring a certain interest rate as well as very appealing in terms of tax exemption, especially for investors who are generally paying high-income taxes (state, federal or local).

Munis are also a great tool for diversification as they are not correlated to equities and are considered ideal for conservative investors due to their lower volatility. Hence, when the stock market is volatile, investors turn to bonds and, especially, to muni bonds as they offer greater safety by being under the jurisdiction of the general government, which can collect the bond proceeds for the project at hand.

On the downside, muni bonds may be downgraded if there are credit issues in the issuing municipality. Also, there is always an interest rate risk, but, usually the Federal Reserve decisions target short-term interest rates. Hence, the longer the maturity of the bond, the less the impact of an interest rate hike.

Summary Definition

Define Municipal Bonds: Muni bond means a debt security issued by a local government to raise funds for capital investments.

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