An Introduction to Tax-Exempt Bonds

Tax exempt bonds are usually issued by individuals and companies to the states and local government units. The bonds are usually issued to generate funds to pay for expenses for which the government does not have enough funding such as roads improvements, construction of schools and the like. Technically, a tax-exempt bond works like a debt instrument and needs to be paid by the debtor, which in this case is the government. These bonds are tax-exempt to allow the issuers to offer lower interest rates to the states and the local government units.

Types of Tax-Exempt Bonds

Generally, there are two types of tax-exempt bonds available in the market, namely the short-term and the long-term bonds. The tax revenue anticipation notes which mature in less than 12 months fall under the short-term category while the general obligations bonds and the assessment bonds fall under the long-term category. The date of maturity of the bonds usually is determined and set at the time the bonds are issued, so make sure that you check the maturity date of the bonds you buy. The date is usually written on the face of the bond instrument.

Buying and Trading the Bonds

If you are an investor, it would be best for you to buy the tax-exempt bonds from the source. Since tax-exempt bonds are actually government bonds, investors can buy these bonds directly from the issuing government office where they are first issued. For instance, if the city government is the bond issuer, investors may be able to buy the bonds directly from the city hall or any authorized office of the city government. Once the bonds are in your hands, you have the option to trade the bonds at the bond markets where other investors may buy through your stock broker.

Tax-Exempt Bond Face Value and Interest Rate

The value of the tax-exempt bond is determined according to the credit worthiness of the issuing government office. The face value of the tax-exempt bond is written on the face of the interest and this value is the actual amount of indebtedness minus the amount of interest due.

Like the face value of the bond, the interest rate is also determined and set at the time of the issuance of the bonds. The annual interest rate is usually fixed and will not change during the lifetime of the bond so if your interest rate is 10 percent, this rate will stay the same until the bond matures.

Advantages and Disadvantages

Compared to other types of investment vehicles such as mutual funds, regular stocks and bonds and the like, tax-exempt bonds are safer. Note that these are government bonds and their values are relatively stable. However, not all tax-exempt bonds offer the same degree of safety so it is best to scrutinize the credit worthiness of the agency issuing the tax-exempt bonds. Also, since the interest rates of these bonds are fixed, you cannot expect to get more out of the bonds at maturity than what has been originally set.

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