2.3 Types of Bonds
Debt instruments encompass sovereign Treasuries, municipal debt, and corporate bonds, each offering distinct credit profiles, tax treatments, and covenants.
Key NASAA Exam Takeaways
- U.S. Treasury securities (T-Bills, Notes, Bonds) are exempt from state and local income tax, but subject to federal tax.
- Treasury Inflation-Protected Securities (TIPS) adjust the principal value semiannually based on CPI.
- Municipal General Obligation (GO) bonds are backed by full faith, credit, and taxing authority; Revenue bonds are backed by project user fees.
- Municipal bond interest is federally tax-exempt, creating significant appeal for high-bracket investors.
- Corporate debentures are unsecured debt backed only by the general credit of the corporation.
| Type | Issuer | Backing | Federal Tax | State/Local Tax |
|---|---|---|---|---|
| Treasury Bonds | U.S. Government | Full Faith & Credit | Taxable | Exempt |
| TIPS | U.S. Government | Full Faith & Credit (CPI adjusted) | Taxable (Principal + Interest) | Exempt |
| Municipal Bonds | States & Cities | Taxes (GO) or Tolls/Fees (Rev) | Exempt | Exempt if in-state |
| Corporate Bonds | Private Corporations | Assets (Secured) or Full Faith (Debenture) | Taxable | Taxable |
Interactive Knowledge Checkpoint • Section 2.3
An investor in the 35% federal tax bracket is comparing a corporate bond paying 8% with a tax-free municipal bond. What is the tax-equivalent yield of the municipal bond if it pays 5.2%?