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Municipal bonds are distributed by governmental entities to gather funds for state administration related day-to-day capital projects like buildings, schools, airports, highways or bridges. The investor lends money in exchange for regular interest payments during the term and getting back the principal amount on maturity. It helps to reduce the borrowing costs of the issuer.
These were first issued in 1971 and the most common reason for investment was low credit risk where even in the condition of bankruptcy, the issuer guarantees the investments plus interest, which helps to lower the market depreciation of these offerings. There can be over 50,000 different types of such entities offered by the government and there is enormous diversity in the terms and interest rates. A short-term option matures between one to three years, whilst long-term can be held for decades. It provides tax exemption on the earnings in the form of interest from such investment but the rate can be very low and the buyer of gets a stream of income payments through it. There can be two types - general obligation and revenue. A general obligation is not protected by any assets. Revenue bonds are offered for certain government / private infrastructure or other projects, like highway tolls.
There are several advantages of such investments - It is tax-free and particularly useful for those in a high tax bracket seeking to create a tax-exempt income stream for retirement. This tax refuge offers liquidity and tax efficiency together in one. Some other advantages are -it is free from state and local taxes. It has lower volatility than stocks and a higher level of liquidity.
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