City bonds are usually called municipal bonds (or munis) and they are issued when a city government needs to finance new projects for public purposes such as schools, highways, or hospitals.
Before answering the question of why a city would issue bonds, it is necessary to answer the question “What is a bond?” in the first place. A definition of a bond states that it can be issued by either a local government (known as municipal bonds, or munis) or businesses (corporate bonds). In both cases, it is a security debt that is owed to holders of the bond by the issuers. The debt is to be paid back at a later date or paid in interest. The United States has one of the major municipal bond markets in the world valued at $3.7 trillion, as stated by the U.S. Securities and Exchange Commission.
Municipal bonds are issued by different government entities such as states, counties, or cities. City bond interest rates are also called coupon bonds, and unlike corporate bonds, they do not fluctuate much. Thus, they are considered low-risk, although there is no bond without any risk at all. Municipal bonds are slightly higher risk investments than federal ones. However, the interest rate for the holder of a city bond might be higher as well. Another advantage of a city bond is that the interest can be exempt from federal income taxes. It sounds very promising for the holders of a city bond, but why are these bonds necessary for cities?
There are two types of muni bonds: general obligations and revenue bonds. The issuers of general obligations guarantee the repayment with “full faith and credit,” and the bonds are unsecured by any assets. However, the issuers have power to tax residents to pay the bondholders. A revenue bond is an opposite type of bonds that are backed by the revenues that a city project generates, e.g., a toll road. Nevertheless, actual income is not guaranteed, and due to any problems with the project, the holders might not be paid the interest.
Despite such benefits as tax-free income, any muni bonds have several risks. According to Investor.gov, there are at least five major risks one should consider before investing. Among them, there is a call risk, which means that a holder might be repaid before the maturity date (the day the issuer must redeem the bond). The default of an issuer is another risk to take, which means one should know the credit rating of an issuer. Interest rate risk is considered low as far as general obligations are concerned, but it cannot be excluded from the list. Inflation might also be an issue as it reduces purchasing power leading to a fixed interest rate. In addition, as many investors buy muni bonds to hold them and not to trade, the market may not be liquid, which causes different quoted prices for the same bond.
However, there are still many potential bondholders who ask the question of where to buy municipal bonds. Investors use many outlets, such as online brokerages, which offer a large variety of bonds to choose. Also, it is possible to contact some local bond dealers who can provide their knowledge about certain bonds and bond areas. There is another way to buy a bond through banks or even address the municipality directly. Before purchasing any bond, it is necessary to do the “homework” and be aware of the risks. However, the municipal bonds are considered to be the safest of all other types of investments.