Many city governments find themselves up against a wall when they need money for day-to-day operating expenses, building new structures, improving existing structures or making repairs. Ongoing expenses, including employee wages, maintenance andinsurance, plus periodic projects including building schools, improving roadways and ensuring the safety of bridges, represent significant costs for city governments. To pay for these costs, a city’s resources include licensing fees and tax payments. But there are times when city budgets simply cannot sustain the city’s operating costs and city coffers come up shorthanded (or empty-handed) to cover expenses or fund needed projects. During times like these, government officials often turn to city bonds as a resource for raising the money.
City bonds work by raising money through investors to pay operating costs and fund city-wide projects.
You may be familiar with municipal bonds because of their appearance on your local tax ballot through a process called a bond referendum. Because bonds can raise taxes, which allows the city to pay the investors (or bondholders), some cities let their voters decide the fate of some bond issues. For example, if the city is considering a new school, it may let its voters decide whether to approve a bond that would fund the school. In other cities, the city government doesn’t have a choice about allowing voters to decide the fate of certain bond issues if the city’s constitution or local ordinances mandate that the taxpayers must cast the deciding vote. Bonds can also raise money to build city airports or repair infrastructures such as roads and bridges.
What Is a Municipal Bond?
Also called muni bonds, or munis, municipal bonds are debt securities. They’re issued by different types of government entities including states and counties. City governments also issue municipal bonds, which are simply called city bonds. Investors earn money on city bonds when the city pays interest on the investment at certain intervals, which are defined in the bond parameters. Bond investors are essentially lending money to a city in return for the interest income they make on the city bonds. And on the maturity date of the bond, the city returns an investor’s initial investment.
Interest Rates and Interest Payments
Bond interest rates are also called coupon rates, and they are typically fixed rates; they do not fluctuate or adjust over the life of the bond. Interest rates follow market trends and can vary widely, depending on which bonds you choose as investments. An interest rate of, for example, 2.3 percent, may not sound very high, but when coupled with the tax-free benefits you’ll receive, the actual overall return on your investment could be 6.5 percent or more. And higher coupon rates will yield higher dividend yields. Because of the tax break, the interest rate for city bonds is lower than other types of taxable bonds such as corporate bonds. City bond investors typically receive interest payments on a semi-annual basis – every six months.
Municipal bonds have widely varying maturities from one year to 30 years. Serial bonds are groups of bonds that mature at different intervals during the series. The series may span 20 years with different maturity dates at each year during the series. Term bonds typically have longer maturity dates; for example, 20 to 30 years. A term bond is usually repaid at a single maturity date or during limited intervals. Although investors can sell municipal bonds before their maturity dates, investors will not receive their full return on investment unless the bonds reach their maturities.