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Safety Characteristics of Municipal Bonds

Municipal bonds are debt obligations issued by a state or its subdivisions. Investors buy them because of their tax-advantaged interest and the "security" offered by a state or municipality. Municipal bonds may be secured or unsecured.

To be secured means to be backed by collateral, as revenue bonds are. To be unsecured is to be without collateral. Investors who choose unsecured bonds must trust the issuer's creditworthiness. As mentioned before, general obligation bonds are of this type.

Many municipal bonds have an interesting additional feature: they may be insured by outside agencies.

Many municipals, especially revenue bonds, have an interesting additional feature: they may be insured by outside agencies. These insurers guarantee that they will pay bondholders their interest and principal if the issuers default. Both individuals and issuers may carry insurance. Individuals must have at least $50,000 in three or more issues before they may buy insurance.

Two well-known municipal bond insurers are the Municipal Bond Insurance Association (MBIA) and the American Municipal Bond Assurance Corporation (AMBAC). There are numerous others. Large commercial banks sometimes guarantee bonds, too.

Insured bonds are rated higher than non-insured bonds. However, they pay lower interest rates.