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2.9 Municipal Bonds

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Securities Industry Essentials SIE

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1 Introduction

About the SIE Exam How to Use This Course

2 Chapter 1: Knowledge of Capital Markets

1.1 Regulatory Bodies 1.2 State Regulation 1.3 Market Participants 1.4 Types of Markets 1.5 The Exchanges 1.6 OTC Markets 1.7 Economic Policies 1.8 Interest Rates 1.9 Business Cycles 1.10 International Economics

3 Chapter 2: Understanding Products and Their Risks

2.1 Common Stock Basics 2.2 Corporate Actions 2.3 Preferred Stock 2.4 ADRs 2.5 Bond Basics 2.6 Yields 2.7 U.S. Treasury Securities 2.8 Corporate Bonds 2.9 Municipal Bonds 2.10 Money Market Instruments 2.11 Options Basics 2.12 Hedging Strategies 2.13 Mutual Funds 101 2.14 Mutual Fund Fees 2.15 ETFs 2.16 UITs & REITs 2.17 DPPs 2.18 Systematic Risk 2.19 Non-Systematic Risk 2.20 Mitigation Strategies

4 Chapter 3: Trading, Customer Accounts and Prohibited Activities

3.1 Order Types 3.2 Trade Settlement 3.3 Quoting 3.4 Account Types 3.5 Account Registration 3.6 Retirement Plans 3.7 Education Savings 3.8 AML Rules 3.9 Market Manipulation 3.10 Insider Trading 3.11 Customer Protection

5 Chapter 4: Overview of Regulatory Framework

4.1 Registration 4.2 Continuing Education 4.3 Employee Conduct 4.4 Correspondence

2.9 Municipal Bonds

Key Takeaways Explain This Topic AI

General obligation (GO) bonds are backed by full faith and credit including taxing power, while revenue bonds are backed only by specific project revenue

Municipal bond interest is generally exempt from federal income tax; triple tax-free when exempt from federal, state, and local taxes in your state

Tax-Equivalent Yield formula: Muni Yield / (1 - Tax Rate)

GO bonds require voter approval and have lower risk/yield; revenue bonds typically don't require voter approval and have higher risk/yield

  • Municipal bonds are most beneficial for investors in the 32-37% tax brackets
  • Last updated: January 2026

Municipal bonds ("munis") are debt securities issued by state and local governments to fund public projects. Their most attractive feature is tax-exempt interest , making them popular with investors in high tax brackets. The SIE exam tests your understanding of muni bond types, tax treatment, and risks.

What Are Municipal Bonds?

Municipal bonds are issued by:

  • State governments
  • City and county governments
  • School districts
  • Public utilities
  • Transit authorities
  • Other local government entities

The proceeds fund public infrastructure: schools, highways, hospitals, water systems, airports, and other community projects.

  • Two Main Types of Municipal Bonds
  • General Obligation (GO) Bonds

General obligation bonds are backed by the "full faith and credit" of the issuing government, including its taxing power.

  • Feature Description
  • Backed by Government's taxing authority
  • Security Property taxes, income taxes, sales taxes
  • Voter approval Usually required
  • Risk level Generally lower (taxing power is strong)

Key Point: GO bonds are only as safe as the government's ability and willingness to raise taxes to pay debt.

Revenue Bonds

Revenue bonds are backed only by the income generated from a specific project or source.

  • Feature Description
  • Backed by Revenue from specific project
  • Examples Toll roads, airports, hospitals, utilities
  • Voter approval Usually not required
  • Risk level Generally higher than GO bonds

Example: A toll bridge revenue bond is repaid from toll collections. If fewer people use the bridge than expected, revenue may be insufficient to pay bondholders.

GO vs. Revenue Bonds Comparison

  • Factor GO Bonds Revenue Bonds
  • Security Full faith and credit Specific revenue source
  • Taxing power Yes No
  • Risk Lower Higher
  • Yield Lower Higher
  • Voter approval Yes No
  • Use of funds General purposes Specific project
  • Tax Treatment of Municipal Bonds
  • Federal Tax Exemption

Interest on municipal bonds is generally exempt from federal income tax . This is their primary advantage.

State and Local Tax Exemption

Interest may also be exempt from state and local taxes if you live in the state where the bond was issued .

Triple Tax-Free

A bond is "triple tax-free" when interest is exempt from:

  • Federal income tax
  • State income tax
  • Local income tax

Example: A New York City resident who buys a New York City municipal bond receives interest that is exempt from federal, New York State, and New York City taxes—triple tax-free.

Tax-Equivalent Yield

Because muni interest is tax-free, investors must compare yields on an after-tax basis. Tax-Equivalent Yield = Muni Yield 1 − Tax Rate \text{Tax-Equivalent Yield} = \frac{\text{Muni Yield}}{1 - \text{Tax Rate}} Tax-Equivalent Yield = 1 − Tax Rate Muni Yield ​

Example:

  • Municipal bond yield: 3%
  • Investor's tax bracket: 35%
  • Tax-equivalent yield: 3% / (1 - 0.35) = 3% / 0.65 = 4.62%

The 3% muni yield is equivalent to earning 4.62% on a taxable bond.

When Munis Make Sense

  • Investor Tax Bracket Benefit from Munis
  • 10-12% Minimal—taxable bonds may yield more
  • 22-24% Moderate benefit
  • 32-37% Significant benefit
  • Types of Municipal Revenue Bonds
  • Type Revenue Source
  • Airport bonds Landing fees, terminal rents
  • Hospital bonds Patient fees, insurance payments
  • Toll road bonds Toll collections
  • Utility bonds Water, sewer, electric fees
  • Industrial development bonds Corporate lease payments
  • Taxable Municipal Bonds

Not all municipal bonds are tax-exempt. Some purposes do not qualify for tax exemption:

  • Sports stadiums
  • Convention centers
  • Private-purpose projects
  • Certain refunding bonds

These taxable municipal bonds pay higher interest to compensate for the tax liability.

Alternative Minimum Tax (AMT)

Some municipal bonds are subject to the Alternative Minimum Tax (AMT) :

  • Private activity bonds may trigger AMT
  • Essential-purpose bonds generally avoid AMT
  • Investors subject to AMT should check bond details
  • Risks of Municipal Bonds
  • Risk Type Description
  • Credit risk Issuer may default (rare for GOs, more common for revenue)
  • Interest rate risk Prices fall when rates rise
  • Call risk Many munis are callable
  • Liquidity risk Less active secondary market than Treasuries
  • Legislative risk Tax laws could change
  • Key Takeaways
  • GO bonds backed by taxing power; revenue bonds backed by project income
  • Municipal bond interest is generally exempt from federal tax
  • Triple tax-free when held by a resident of the issuing state
  • Use tax-equivalent yield to compare munis to taxable bonds
  • Higher tax bracket = greater benefit from tax-exempt bonds
  • Revenue bonds are riskier than GO bonds but offer higher yields