Legal Definitions - municipal bonds

A municipal bond (often shortened to "muni bond" or "muni") is essentially a loan made by an investor to a state, county, or local government. When you purchase a municipal bond, you are lending money to a government entity, which then uses those funds to finance public projects and services. In return, the government promises to pay you back the original amount (the principal) plus interest over a specified period.

These bonds are a crucial tool for governments to raise capital without increasing taxes immediately. They are typically used to fund large-scale public works that benefit the community, such as building infrastructure, improving public services, or developing community facilities. A key feature that makes municipal bonds attractive to investors is that the interest earned is often exempt from federal income tax, and sometimes from state and local taxes as well, depending on where the investor lives and where the bond was issued. This tax-exempt status can make them a valuable part of an investment portfolio.

Municipal bonds generally come in two main forms:

• General Obligation Bonds: These are backed by the full faith and credit of the issuing government. This means the government pledges its general taxing power to repay the bondholders. If necessary, the government can raise taxes or reallocate funds from other areas to ensure the bonds are repaid.
• Revenue Bonds: These bonds are repaid using the income generated by the specific project they funded. For example, if a bond funds a new toll bridge, the tolls collected would be used to pay back the bondholders. The government's general tax revenue is not typically pledged for revenue bonds.

Here are some examples of how municipal bonds are used:

• Example 1: Modernizing Public Transit (General Obligation Bond)

  A large metropolitan city decides to completely overhaul its aging public bus system, replacing its entire fleet with electric vehicles and expanding service routes to newly developed suburbs. To fund this multi-year, multi-million-dollar project, the city issues general obligation municipal bonds. Investors purchase these bonds, providing the city with the necessary capital. The city commits to repaying these bondholders using its general tax revenues, such as property taxes and sales taxes collected from its residents and businesses. This illustrates a general obligation bond because the repayment is not tied to the specific revenue generated by the bus system itself (like ticket fares), but rather by the city's overall financial health and its ability to tax its citizens.

• Example 2: Constructing a New Airport Terminal (Revenue Bond)

  A state airport authority plans to build a brand-new international terminal to accommodate increasing passenger traffic and larger aircraft. To finance this massive construction, the authority issues revenue municipal bonds. The bond prospectus specifies that the principal and interest payments to investors will be made exclusively from the revenues generated by the new terminal, such as landing fees from airlines, concession rentals from shops and restaurants within the terminal, and passenger facility charges. This is a revenue bond because the repayment is directly linked to and secured by the income stream produced by the specific project it funded, rather than the state's general tax base.

• Example 3: Upgrading County Water Infrastructure (General Obligation Bond)

  A rural county government identifies a critical need to replace thousands of miles of old, corroded water pipes and upgrade its main water treatment plant to meet new environmental standards. Given the essential nature of clean water for all residents and the broad scope of the project, the county issues general obligation municipal bonds. The county assures investors that these bonds will be repaid from its general fund, which is primarily supported by property taxes and other fees collected from all county residents. This demonstrates a general obligation bond because the project benefits the entire community, and the repayment obligation rests on the county's overall financial capacity and its power to collect taxes from its population.