What are municipal bonds?

What Are Municipal Bonds?

Municipal bonds are debt instruments issued by local governments or their agencies to finance public projects. Essentially, you lend money to a city or state, and in return, they pay you periodic interest and return your principal at maturity.

These funds are typically used for projects like road construction, building schools and hospitals, or developing water infrastructure. Many municipal bonds offer tax advantages at the federal or state level, making them popular among investors in higher tax brackets. In the United States, the total outstanding market for municipal bonds is valued in the trillions of dollars (Source: SIFMA, 2024).

How Do Municipal Bonds Work?

Municipal bonds pay interest at a predetermined rate and return your principal at maturity. The agreed-upon interest rate is called the “coupon rate,” which reflects the annual percentage of interest paid on the principal.

When evaluating overall returns, investors often look at “yield to maturity” (YTM), which factors in your purchase price, periodic interest payments, and the principal received at maturity, converting this to an annualized real return. YTM fluctuates with market prices.

Many municipal bonds include “call provisions,” allowing issuers to repay the principal before maturity on specified dates. If market rates fall, issuers may redeem bonds early and reissue at lower rates, impacting future interest income for investors.

Municipal bonds are also assigned “credit ratings,” which measure repayment ability—much like a grading system. Higher ratings generally indicate lower default risk but usually come with lower yields. Most trading occurs over-the-counter (OTC), and pricing reflects factors such as interest rates, creditworthiness, and liquidity.

Types of Municipal Bonds

The two main categories are “General Obligation Bonds” and “Revenue Bonds.” General obligation bonds are backed by the overall finances of the issuing municipality, while revenue bonds are repaid from cash flows generated by specific projects, such as toll roads or utility fees.

Based on tax status, there are “tax-exempt municipal bonds” and “taxable municipal bonds.” Tax-exempt typically refers to federal tax exemption, with some states also exempting their residents; taxable municipal bonds require interest income to be reported for taxes but may fund projects not eligible for tax exemption.

By maturity, there are short-term notes (several months up to about a year) and long-term bonds (multiple years or decades). Short-term notes are used for cash management; long-term bonds are more sensitive to interest rate fluctuations.

How Are Municipal Bond Returns and Taxes Calculated?

Returns on municipal bonds come from two sources: coupon interest payments and gains or losses from buying and selling the bond. Many investors focus on “after-tax yield.”

For example, if a tax-exempt municipal bond offers a 4% yield to maturity and a comparable taxable corporate bond yields 5%, with your marginal tax rate at 24%, the after-tax yield on the corporate bond would be approximately 5% × (1−24%) = 3.8%, which is less than the tax-exempt municipal bond’s 4%. This explains why investors in higher tax brackets often prefer tax-exempt municipals.

Important note: The scope of tax exemption varies at federal, state, and local levels. Interest from out-of-state municipals may still be taxable in your state of residence; capital gains (buying low, selling high) are usually still subject to tax. Always consult current regulations and seek professional advice for accurate tax planning.

What Are the Risks of Municipal Bonds?

Municipal bonds are not without risk. Key risks include:

• Interest Rate Risk: When market rates rise, existing bond prices usually fall; if you sell before maturity, you might incur a loss.
• Credit Risk: If an issuer’s finances deteriorate, interest or principal payments could be delayed or lost. Notable defaults include Detroit (2013 bankruptcy) and Puerto Rico (2016 debt crisis).
• Liquidity Risk: Some municipal bonds trade infrequently, making it harder to sell quickly at a favorable price.
• Call Risk: Bonds with call provisions may be redeemed early during falling interest rate cycles, reducing future interest income.
• Inflation Risk: Rising inflation erodes the purchasing power of fixed interest payments.

Long-term data shows investment-grade municipal bonds have a low cumulative default rate (for example, Moody’s research covering 1970–2022 found lower default rates than corporate bonds; Source: Moody’s 2023 Default Study). However, low risk does not mean zero risk—position sizing and diversification remain crucial.

How to Buy and Trade Municipal Bonds

You can buy individual municipal bonds through brokers or invest indirectly via funds or ETFs. A basic approach involves:

Step 1: Clarify Tax and Investment Goals. Know your marginal tax rate and your state’s exemption rules; decide if your priority is stable cash flow or higher yield.

Step 2: Choose Bond Type and Maturity. General obligation and revenue bonds carry different risks; short-term bonds are more stable, while long-term ones experience greater volatility. Match bond maturities to your investment horizon.

Step 3: Compare Yields and Terms. Pay attention to yield to maturity, call provisions, credit ratings, and transaction prices. Callable bonds may have compressed returns in falling rate environments.

Step 4: Select Channels and Assess Costs. Broker commissions and bid-ask spreads impact net returns; funds and ETFs charge management fees but offer easy diversification.

In crypto markets, most platforms do not directly offer municipal bonds. Stablecoin yield products are commonly used for cash management alternatives. On Gate’s stablecoin savings or flexible products, risks and returns differ from those of municipal bonds—they involve smart contracts and market volatility risks. Always review product terms and risk disclosures before investing.

How Do Municipal Bonds Compare to Treasuries and Corporate Bonds?

Compared with U.S. Treasuries: Treasuries are backed by the federal government’s credit, making them lower risk and more liquid but without local tax benefits; municipal bonds can deliver higher after-tax returns for investors in high tax brackets.

Compared with Corporate Bonds: Corporate bonds rely on company cash flows and have historically higher default rates; municipal bonds’ tax-exempt status and public project backing give them unique risk-reward characteristics. The municipal market is more fragmented with varied disclosure practices—trading experiences differ from those with Treasuries or corporate bonds.

What Is the Connection Between Municipal Bonds and Web3?

Municipal bonds intersect with Web3 primarily through RWA (Real World Asset) tokenization, which enables more efficient settlement and disclosure. RWA refers to representing traditional asset ownership on-chain via tokens, increasing transparency and programmability.

By mid-2024, on-chain RWA assets have surpassed several billion dollars in value—fixed income assets show significant growth (Source: rwa.xyz, mid-2024). Although U.S. Treasuries and money market funds dominate today’s RWA space, municipal bonds also hold tokenization potential:

• Issuance & Registration: Blockchain can serve as an immutable ledger to enhance disclosure accessibility and timeliness.
• Settlement & Payments: Stablecoins can facilitate coupon payments and principal settlement, lowering cross-institution settlement costs.
• Compliance & Access: Municipal bonds are subject to local regulations and investor qualifications; tokenization must align with regulatory frameworks—currently an evolving field.

Some funds have already mapped underlying fixed-income assets on-chain for share registration and transfer; however, broad adoption for municipal bonds depends on regulatory clarity and liquidity development.

Who Should Consider Municipal Bonds? How to Allocate Them?

Municipal bonds suit those in higher tax brackets seeking stable cash flow with relatively low default risk tolerance—for example, high-income but conservative investors or retirement accounts needing regular income (where compliant).

For allocation strategy:

• For stable cash flow: Focus on investment-grade tax-exempt municipals as core holdings; complement with some Treasuries for liquidity.
• For higher yield: Add revenue bonds or longer maturities selectively—manage position size carefully and diversify across regions/projects.
• In combination with Web3: Use stablecoin products for short-term liquidity needs but recognize their distinct risks compared to municipals; for long-term income streams, stick to compliant bonds or funds.

Key Takeaways on Municipal Bonds

Municipal bonds are financing tools for public sector projects; investors earn interest and principal repayments, while tax advantages make them attractive for high-tax individuals. Understanding coupon rates, yield to maturity, and call provisions helps assess real returns; being aware of interest rate, credit, and liquidity risks prevents mistaking “low default risk” for “no risk.” Transaction channels and costs impact net returns; compared to Treasuries or corporate bonds, municipals offer unique after-tax benefits and risk profiles. RWA tokenization and stablecoin settlement in Web3 are evolving trends—but compliance and liquidity remain central concerns. Any investment decision should consider your own tax situation, risk tolerance, diversification needs, and robust risk management.

FAQ

What Is the English Term for 市政债券?

The English term is “Municipal Bond,” commonly abbreviated as “Muni.” These are bonds issued by U.S. local governments or special-purpose entities to finance public projects—a frequently used term in financial literature and platforms.

Can I Sell My Municipal Bond Anytime After Purchase?

Municipal bonds can be sold on the secondary market but may not always fetch your desired price immediately. Bond prices fluctuate with changing interest rates; selling at different times can result in varying outcomes. It’s recommended to check liquidity information on regulated platforms like Gate before making decisions.

What Is the Fundamental Difference Between Bonds and Stocks?

Bonds represent debt—you lend money to an issuer in exchange for regular fixed interest payments; stocks represent ownership—you become a company shareholder with potential dividends and capital gains. In short: buying a bond makes you a lender; buying a stock makes you an owner—bonds generally carry lower risk but offer more stable returns.

Why Do Municipal Bonds Have Tax Benefits?

To encourage public investment in local infrastructure, the U.S. federal government exempts municipal bond interest from federal income tax; some states also waive state taxes for residents. These incentives make municipal bonds especially appealing to high-tax-bracket investors who want to support local development.

How Should Beginners Buy Their First Municipal Bond?

First clarify your investment horizon and risk tolerance; choose highly-rated (e.g., AAA) bonds to minimize default risk. Use regulated platforms like Gate to review details such as yields and liquidity; start with small allocations—not exceeding 20% of your assets—and keep sufficient emergency funds available.