Municipal Securities

Unlike corporate bonds, which are fully taxable, municipal securities offer a major tax advantage: their interest is generally exempt from federal income tax. This makes them a frequently tested topic on the SIE exam.

Municipal Bond Basics

• Issued by state and local governments (cities, counties, school districts, public authorities)
• Interest is generally exempt from federal income tax
• May be double-exempt (federal + state) if the investor resides in the issuing state
• May be triple-exempt (federal + state + city) in certain jurisdictions (e.g., New York City)
• Par value: $1,000 per bond, the same as corporates. The standard minimum denomination is $5,000, or five bonds
• Private activity bonds may be subject to the Alternative Minimum Tax (AMT)

Think of it this way: Municipal bonds are the tax-free option in the bond world. Investors in higher tax brackets benefit the most because the tax savings are worth more to them. A 5% tax-free yield beats a 6% taxable yield for someone in the 37% bracket.

Exam Tip: Gotchas

• Municipal par is $1,000, the same as a corporate bond. What differs is the minimum denomination: municipals normally trade in $5,000 blocks (five bonds). Do not confuse the block size with the par value of one bond.
• The tax exemption covers interest income only, not capital gains. If a municipal bond is sold at a price above the investor's cost basis, the profit is a taxable capital gain subject to federal (and typically state) capital gains tax. The "tax-free" label refers to the periodic interest payments the bond generates while held, not to any gain on the sale.

General Obligation (GO) Bonds

GO bonds are the safer of the two main municipal bond types:

• Backed by the full faith, credit, and taxing power of the issuing municipality
• Repaid from ad valorem (property) taxes and general revenues
• Require voter approval in most cases
• Subject to statutory or constitutional debt limits
• Considered safer because the municipality can raise taxes to pay bondholders

Think of it this way: GO bonds are backed by the government's power to tax. As long as people live in the city and own property, the city can collect taxes to pay you back. That is why GO bonds are considered safer.

Revenue Bonds

Revenue bonds are backed by specific project income rather than taxing power:

• Backed by revenue from a specific project or facility (toll road, hospital, airport, utility)
• No taxing power backing; if the project fails to generate revenue, bondholders may not be paid
• Do NOT require voter approval
• Include a feasibility study before issuance to assess the project's viability
• Typically offer higher yields than GO bonds from the same issuer (more risk = more reward)

Exam Tip: Gotchas

• GO bonds require voter approval; revenue bonds do NOT. Revenue bonds are repaid from project income, so taxpayers do not need to approve them.
• Revenue bonds have higher yields because they carry more risk (no taxing power as backup).

GO vs. Revenue Bonds Comparison

Other Municipal Securities

• Industrial Development Revenue Bonds (IDRBs): issued by municipalities to finance private facilities; backed by the private corporation, NOT the municipality
• Taxable municipal bonds: issued for purposes that do not qualify for tax exemption (e.g., pension funding); interest is federally taxable
• Build America Bonds (BABs): taxable municipal bonds where the federal government provides a subsidy to the issuer

Exam Tip: Gotchas

• IDRBs are backed by the private corporation using the facility, NOT by the municipality that issued them. The municipality's name is on the bond, but the corporation carries the credit risk.

Short-Term Municipal Obligations

Municipal Bond Disclosures

• The Official Statement (OS) is the municipal equivalent of a prospectus
• Provides material information about the issuing entity and the bond terms
• The dealer must deliver the OS to the customer by no later than settlement of the transaction
• Municipal bonds are exempt from SEC registration under the Securities Act of 1933
• However, they are NOT exempt from antifraud provisions
• The Municipal Securities Rulemaking Board (MSRB) regulates municipal securities dealers (broker-dealers and banks), NOT the issuers themselves
• FINRA enforces MSRB rules on broker-dealers; the MSRB itself does not enforce its own rules (unlike other self-regulatory organizations)
• Issuers provide continuing disclosure (annual financial information and material-event notices) to the MSRB's EMMA system, not directly to the SEC. This duty is enforced through the underwriter, who must obtain the issuer's promise to keep disclosing before bringing the bonds to market. The SEC's own oversight of muni issuers rests on the antifraud provisions
• The MSRB's fair-dealing rule requires fair dealing in all municipal securities transactions

Exam Tip: Gotchas

• Municipal bonds are EXEMPT from SEC registration, but NOT exempt from antifraud provisions. Fraud is never allowed, even for exempt securities.
• The MSRB regulates dealers, NOT issuers. State and local governments that issue munis fall outside the MSRB's reach. Congress built this in via the Tower Amendment (1975).
• FINRA enforces MSRB rules on broker-dealers. The MSRB writes the rules; FINRA polices compliance. This is different from how other SROs work.
• The SEC still has antifraud jurisdiction over muni issuers, even though it doesn't require muni registration. The SEC's antifraud provisions and continuing-disclosure requirements both reach issuers, even though registration does not.

What Should You Check on Exam Day?

• Can you explain the difference between GO bonds and revenue bonds in backing and voter approval?
• Do you know which entity, GO or revenue bonds, requires a feasibility study before issuance?
• Can you state what the municipal tax exemption covers, and what it does not cover?
• Do you know whether the MSRB regulates municipal issuers or municipal securities dealers?
• Can you explain who bears the credit risk on an Industrial Development Revenue Bond?