Which statement about municipal bonds is true?

Which statement about municipal bonds is true?

• A. They are issued by state and local governments and interest is tax-exempt.
• B. They are issued by private corporations and interest is taxable.
• C. They are not backed by any tax revenue.
• D. They never default.

Answer: (A)

Municipal bonds are debt securities issued by state and local governments and their agencies to fund public projects. The big feature to remember is the tax treatment: the interest on most municipal bonds is exempt from federal income tax, and if you reside in the issuing state it can also be exempt from state and local taxes. This tax-exempt status is what makes them particularly appealing to investors in higher tax brackets, because the after-tax yield can be more favorable than taxable bonds with a similar before-tax yield. The statement is the best fit because it correctly identifies who issues municipal bonds and the favorable tax treatment of the interest. Some bonds in this category can be taxable, such as certain private activity bonds, and not all municipal bonds are backed by tax revenue—many are secured by dedicated taxes, while others are backed by specific revenue streams. Also, while defaults can occur, they are not something to assume as a universal rule; default risk exists but is typically lower than for many corporate bonds.

Municipal bonds are debt securities issued by state and local governments and their agencies to fund public projects. The big feature to remember is the tax treatment: the interest on most municipal bonds is exempt from federal income tax, and if you reside in the issuing state it can also be exempt from state and local taxes. This tax-exempt status is what makes them particularly appealing to investors in higher tax brackets, because the after-tax yield can be more favorable than taxable bonds with a similar before-tax yield. The statement is the best fit because it correctly identifies who issues municipal bonds and the favorable tax treatment of the interest.

Some bonds in this category can be taxable, such as certain private activity bonds, and not all municipal bonds are backed by tax revenue—many are secured by dedicated taxes, while others are backed by specific revenue streams. Also, while defaults can occur, they are not something to assume as a universal rule; default risk exists but is typically lower than for many corporate bonds.