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municipal bond

n. a bond issued by a state or local government

Municipal bond

A municipal bond is a bond issued by a local government or territory, or their agencies. The term municipal bond is commonly used in the United States, which has the largest market of such trade-able securities in the world estimated at $3.7 trillion in 2011. Potential issuers of municipal bonds include states, cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) at or below the state level having more than a de minimis amount of one of the three sovereign powers: the power of taxation, the power of eminent domain or the police power. Municipal bonds may be general obligations of the issuer or secured by specified revenues.

Many countries in the world also issue municipal bonds, sometimes called local authority bonds or other names. The key defining feature of this type of bond is that it is issued by a public-use entity at a lower level of government than the sovereign. A default of the local bond should not automatically trigger a default on the sovereign bonds. The U.S. municipal bond market is unique for its size, liquidity, legal and tax structure and bankruptcy protection afforded by the U.S. Constitution.

In the United States, interest income received by holders of municipal bonds is often excludable from gross income for federal income tax purposes under Section 103 of the Internal Revenue Code, and may be exempt from state income tax as well, depending on the applicable state income tax laws. The state and local exemption was the subject of recent litigation in Department of Revenue of Kentucky v. Davis, 553 U.S. 328 (2008).

Unlike new issue stocks that are brought to market with price restrictions until the deal is sold, most municipal bonds are free to trade at any time once they are purchased by the investor. Professional traders regularly trade and re-trade the same bonds several times a week. A feature of this market is a larger proportion of smaller retail investors compared to other sectors of the U.S. securities markets. Some municipal bonds, often with higher risk credits, are issued subject to transfer restrictions.