What are Municipal Munis?
Municipal munis are a type of zerocoupon bond. Zerocoupon bonds are bonds that do not make periodic interest payments. Instead, they are issued at a deep discount to their face value, which the investor receives when the bond matures. Municipal munis are issued by state and local governments to finance public projects like roads, bridges, and schools.
Definition of a Zerocoupon Bond
A zerocoupon bond is a debt security that doesn’t make periodic interest payments. Instead, it’s sold at a deep discount from its face value, which the investor receives when the bond matures. Zerocoupon bonds are also known as accrual bonds or deep discount bonds.
How do Zerocoupon Bonds Work?
A zerocoupon bond is a debt security that doesn’t pay periodic interest. Instead, the entire principal of the bond is invested at an interest rate that’s locked in when the bond is issued. When the bond reaches its maturity date, the investor receives one lump sum equal to the initial investment plus interest.
Municipal munis are zerocoupon bonds issued by state and local governments to finance public projects such as road construction or school renovation. The bonds are typically issued with maturities of 10 to 30 years, although some municipalities also offer bonds with shorter terms of five years or less.
The Benefits of Municipal Munis
Municipal munis are a type of debt security issued by state and local governments in the United States. They are exempt from federal, state, and local taxes, making them a very attractive investment for tax-exempt investors. Municipal munis are also considered to be very safe investments, as they are backed by the full faith and credit of the issuing government.
One of the chief benefits of investing in municipal bonds is that the federal government exempts the interest payments from federal income taxes. This exemption also applies to state and local taxes, making munis attractive to higher-income investors who are in upper tax brackets and subject to higher marginal tax rates.
Municipal bonds are also exempt from the alternative minimum tax (AMT). The AMT is a separate tax calculation that disallows or limits many common deductions, such as state and local taxes. This can result in a higher tax bill for some taxpayers. By owning municipal bonds, you can avoid paying the AMT.
Lower Interest Rates
Municipal bonds, also called munis, are debt securities issued by state and local governments to finance public projects such as highways, bridges, and schools. Interest on munis is exempt from federal income tax, and in some cases, from state and local taxes as well. For this reason, they are often referred to as “tax-exempt” securities.
Munis typically have lower interest rates than taxable bonds because the investor’s after-tax yield is higher. For example, if a taxable bond has a 6% coupon rate and is held in a 28% tax bracket, the investor’s after-tax yield would be 4.32%. In contrast, if a comparable muni had a 5% coupon rate, the investor’s after-tax yield would be 5%.
The interest rate on a muni is usually lower than on a comparable taxable bond because the investor’s after-tax yield is higher.
The tax advantage of munis makes them an attractive investment for individuals in high tax brackets who are looking for income that is sheltered from taxes.
Municipal bonds, also called munis, are debt securities issued by states, cities, counties and other government entities to finance public projects such as roads, schools and utilities.
Municipal bonds typically offer two major advantages: federal tax exemption and state tax exemption. The tax-exempt status of municipal bonds makes them especially attractive to investors in high tax brackets.
Municipal bonds are generally classified as either general obligation or revenue bonds. General obligation bonds are backed by the full faith and credit of the issuing government entity, while revenue bonds are backed only by the revenues generated by the specific project financed by the bond issue.
Because they are backed by the full faith and credit of the issuing entity, general obligation bonds typically have lower interest rates than revenue bonds. However, revenue bonds may offer higher yields than general obligation bonds of comparable maturity because they are considered to be more risky.
Muni Bonds 101: The Basics of Investing in Municipal Bonds
See:1. premium bonds, 2. municipal revenue bonds: how they work and what you need to know.
The Risks of Municipal Munis
Municipal munis are a type of zerocoupon bond. Zerocoupon bonds do not make periodic interest payments. Instead, they are sold at a deep discount from face value, and they mature at face value. For example, a $10,000 zerocoupon bond with a 20-year maturity may be sold for $5,000.
Municipal bonds, or “munis,” are debt securities issued by states, cities, and local government authorities to finance public projects such as roads, schools, and water systems. Because munis are exempt from federal taxation, they typically offer lower yields than taxable bonds. For this reason, munis are often thought of as a “safe” investment.
However, munis are not without risk. One risk is that of default, which occurs when the issuing entity is unable to make interest or principal payments on its debt. Although defaults on municipal bonds are relatively rare, they can and do happen. This risk is usually greater for bonds issued by smaller entities with less diverse revenue sources.
For example, in 2011 the city of Harrisburg, Pennsylvania defaulted on a number of its general obligation bonds. The city had been facing financial difficulties for several years, and the defaults were the culmination of a lengthy battle between the city and its bondholders. In the end, Harrisburg was forced to file for bankruptcy protection.
Investors in municipal bonds should be aware of the risk of default before investing. However, for most investors, the potential rewards outweigh the risks.
Interest Rate Risk
Municipal bonds are often lauded as being low risk, but there is one potential risk that investors need to be aware of: interest rate risk.
When interest rates rise, the value of existing bonds falls. This is because bonds are effectively loans, and when rates go up, new bonds are issued at a higher rate, making existing bonds less attractive.
For example, let’s say you have a bond that pays 5% interest and interest rates rise to 6%. The value of your bond falls because now there are new bonds being issued that pay 6% interest. Investors are willing to pay less for your 5% bond because they can earn a higher return elsewhere.
This is why it’s important to consider the current level of interest rates when deciding whether or not to invest in municipal bonds. If rates are low and you think they may rise in the future, you may want to reconsider investing in municipal bonds.
Municipalities issue tax-exempt bonds to finance public projects like highways, schools, and hospitals. The securities are often called “munis” for short. Investors in munis are typically attracted by the interest payments, which are exempt from federal taxes. But there is another important consideration: reinvestment risk.
Reinvestment risk is the risk that an investor will not be able to reinvest their interest payments at the same rate when it comes time to roll over their investment. This risk is amplified in the case of munis because these securities typically have long maturity dates – 20 or 30 years is not uncommon. That means that an investor in a muni could be faced with the challenge of finding another investment that pays a comparable yield after 20 or 30 years.
Of course, reinvestment risk is not unique to munis – any bond with a long maturity date will carry this risk. But it is something that investors in munis should be aware of, and it’s one of the reasons why these securities are not suitable for everyone.
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