Municipal Bonds

In order to raise funds for public purposes, the states, cities, or local government entities issue bonds or debt securities. These bonds or debt securities are called ‘Municipal Bonds’. Municipalities issue bonds to raise capital for their day-to-day activities and for specific projects such as — building schools, hospitals, constructing a new sewage systems, and expanding highways etc.

When an investor purchases a municipal bond, he lends money to the government entity that issued the bond. In exchange, the government entity promises to pay him a specified amount of interest, usually semiannually, and returns his principal amount on a specified maturity date.

Interest on municipal bonds is generally exempt from federal tax. In the case that the bond is bought by a resident of the state that issued the bond, the interest payments are also exempt from state tax. Interest payments are further exempt from local tax if residents of the locality that issued the bond buy them.