Types of Bonds
Understanding the Municipal Bond Market
To understand how zero coupon municipal bonds work, it is important first to become acquainted with the principal characteristics of both municipal bonds and the zero coupon structure.
Municipal bonds are the debt obligations of states, their political subdivisions and certain agencies and authorities. The municipal bond market is one of our nation’s most remarkable institutions, providing a mechanism whereby more than 50,000 state and local government units can raise money for public purposes such as water and sewer systems, schools, highways and public buildings.
Under present federal income tax law, the interest income from municipal bonds is exempt from federal income taxes.* In most states, interest income received from bonds issued by governmental units within the investor’s own state is also exempt from state and local income taxes (see table). Interest income from bonds issued by U.S. territories and possessions is exempt from federal, state and local income taxes in all 50 states as well.
In addition to offering tax advantages, municipal bonds have had an extraordinarily good record of paying interest and principal on time. In the past 50 years, less than one percent of the hundreds of thousands of municipal bonds issued have gone into default.
Individual ownership of municipal bonds purchased directly or through mutual funds, has grown from approximately $130 billion in 1980 to $1,852 billion at the end of 2007.
For more detailed information on municipal securities, you may want to ask your account representative for a copy of An Investor’s Guide to Municipal Bonds, available from the Securities Industry and Financial Markets Association.
* If you are subject to the alternative minimum tax (AMT), you may need to include interest income from certain municipal securities in calculating your income tax.
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.