Definition of Municipal Bond
Municipal bond are issued from the government municipality or state. These bonds are tax-free and are used to finance government projects for the welfare of society. These bonds are raised when the government of the state is in need of money. The government offers these bonds to the public and raises money. The taxpayers can also get benefit from the investment in these bonds. These are treated as an investor’s loan to purchase municipal bonds.
Explanation
Municipal bonds are bonds that the government issues to finance government projects, i.e., building roads, constructing bridges, repairs, and maintenance of public properties, etc. These bonds are also known as debt securities which are treated as a loan for any investor. These bonds can be quickly sold out to other prospective investors at their convenience. Whenever any investor purchases this bond, it is assumed that the investor is lending money to the government; in this case, the government will be known as the issuer. In return for this, the government will promise to pay a certain amount of interest to the investor and will repay the bond’s book value as well. These bonds are also gaining popularity because they are tax-free in the investors’ hands.
Characteristics of Municipal Bonds
- These bonds are debt securities, meaning they are a kind of debt that the investors give to the government.
- These bonds are tax-free, so the investors are not required to pay any tax.
- The government issues these bonds to finance government projects used for the public as a whole.
- The government will repay the principal and this bond’s interest value after it matures.
How Does Municipal Bond Work?
Municipal bonds are issued when there is money required for government projects. Whenever these bonds are given to the public, the investor purchase the bonds, and then the debt is created. The government must pay back the principal and interest on these bonds. Usually, the claim is paid within 6 months until the due date comes. On the due date, the face value and the entire outstanding interest amount are being paid. This is how the municipal bond works.
Example:
These bonds are used to finance government projects i.e. construction of new roads or repairs of old roads, the building of bridges, etc.
Types of Municipal Bond
- General Obligation bond: General obligation bonds are bonds that are issued by government entities and are generally riskier and can provide much higher returns in comparison to other municipal bonds.
- Revenue Bonds: Revenue bonds are also issued from government entities but are secured and less risky.
- Risks of Municipal Bond: The risk factor in these bonds can be varied. There are certain municipal bonds that are secured and are less risky whereas there are certain municipal bonds that are less secured and are very much risky. The uncertainty of repayment is always there and therefore it cannot be said that municipal bonds are not risky at all.
- Taxability of Municipal Bond: The interest on these bonds is tax-free in India. Therefore these bonds are very popular among investors.
- Guidelines for Municipal Bond: Recently municipal bonds are gaining popularity in India as well. Municipal bonds are a secure and less risky option for any investor to invest in it. Nowadays government has relaxed the provisions of municipal bonds and thus it becomes easy for investors to invest their proceeds in municipal bonds.
Advantages
- These bonds are tax-free and therefore these are popular among investors.
- These bonds also help the government in raising the funds for the development of the public as a whole.
- The investment in bonds is also very secure in comparison to other investment options.
- Municipal bonds offer some very flexible options for investors therefore they can easily plan their financials accordingly.
- These bonds are also strategically made for the purpose of the investment.
- These bonds are safe and secure and less risky.
- These bonds pay taxes every six months therefore tax planning can be done very easily.
- The investment in municipal bonds is also for the long term and therefore the investor can easily do all the required planning for their investments.
Disadvantages
- These bonds pay less interest to the investors and therefore some class of investors will not get any interest in investing in municipal bonds.
- Sometimes in the case of municipal bonds, the returns are not guaranteed. Thus the investor may lose faith and interest in that bond.
- These bonds are less risky and more secured but sometimes these bonds cannot be secured and may give a negative impact on the returns of the investors.
- Another challenge that is very common with these bonds is that the issuer i.e. the government entity is so small that they are unable to repay the amount taken as a loan in the name of these bonds from the investors.
Conclusion
Municipal bonds are bonds that are secured and less risky than compared to any other securities. These bonds are becoming very popular nowadays and therefore investors are investing in these types of bonds. These bonds are issued by the local authorities and are also tax-free in the hands of the investors. These bonds pay less interest to the investors and thus some class of investors is not interested in investing in such bonds. These bonds also provide a long-term investment plan and the interest is due every 6 months, therefore, the investor can make all necessary planning for their portfolio.
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