Municipal Bond
A bond issued by a state, city, or local government to fund public projects, typically tax-exempt.
What is Municipal Bond?
A municipal bond (or 'muni') is a debt security issued by a state, county, city, school district, or other local government entity to finance public infrastructure projects such as roads, bridges, hospitals, and schools. The defining feature of most municipal bonds is that their interest income is exempt from federal income tax — and often state and local taxes for investors residing in the issuing state. This tax advantage makes municipal bonds particularly attractive to investors in high tax brackets, who compare the after-tax yield of munis against taxable alternatives using the tax-equivalent yield formula.
Example
A California investor in the 37% federal tax bracket considering a California municipal bond yielding 3.5% (exempt from both federal and California state taxes) would need a taxable bond to yield approximately 5.6% to provide the same after-tax income. This 'tax-equivalent yield' calculation shows why high-income investors often prefer munis despite their lower stated yields.