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Munis - municipal bonds - are issued by states, counties, and cities to finance local government operations. Coupon payments typically occur every 6 months, but that is not always the case. They are considered very safe since few local governments go bankrupt. But it does happen. For example, in December 1994, Orange County, Ca admitted losing $1.6 billion, and shortly afterwards announced bankruptcy.
Munis have the very unique advantage of being exempt from federal taxes. Additionally, some local governments will make the bonds tax exempt. that's right - bonds can be completely tax free!! However, the low risk and tax exemption status results in lower interest rates. Additionally, some municipal bonds may not be exempt from the AMT (Alternative Minimum Tax).
Since munis carry unique tax advantages, it can be misleading to directly compare the interest rates of munis and other bonds. The formula for determining a comparable municipal bond rate is:
(corporate bond rate * (1 - tax rate)) * 100 = comparable municipal bond rate
eg: (assuming 10% corporate bond rate, 30% tax rate)
(0.10 * (1 - .30)) * 100 = 7%
Using the numbers from the example, it would take a 10% corporate bond rate to equate to the returns from a tax free municipal bond if the investor had a 30% tax rate.
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