Bonds can simply be termed as loans since purchasing bonds is lending money to another entity who is the issuer. Different types of relationships vary depending on the issuer, maturity period, the risks involved, and the interest rates. They include government bonds, corporate bonds, and municipal bonds, among others. This paper aims to compare the relative levels of investment returns, tax considerations applied to the performances, and the risks associated with the government (Treasury bonds) and municipal bonds.
Comparative Level of Investment Returns
Both the municipal bonds and the government bonds have a low-interest payment as compared to other bands like the corporate bonds mainly because of their tax advantage and the fact that the providers back them, so the issuers do not necessarily need to offer rates that are high to attract the investors. The municipal bonds yield some returns through a collection of interest payments regularly and usually. The interest payments are not taxed at the federal level. Purchase of municipal bonds that are issued by the home state leads to the exemption of both local and state taxes leading to higher yields.
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Equally, government bonds yield tax-free income. However, the investment return of government bonds can be higher compared to that of the municipal bonds because the city bonds their capability of the state or local governments increasing taxes to cover debts which are different for government bonds since the federal government guarantees them. The government bonds’ interest rates have ranged between 2-15% since 1990, and have had an average of 4.9%. But by comparison, on the tax-adjusted basis, the municipal bonds have yielded 25% to 30% more than the government bonds (U.S. Financial Data - St. Louis Fed, n.d.).
Tax considerations
Every interest income that is obtained from the government bonds two times per year is subjected to the federal income taxes, but it is exempted from state and local income taxes ( Alexander, 2008) . Most of the municipal bonds are usually exempted from the federal, provincial and state taxes in those states that they are issued although other municipal bonds are prone to federal taxations although the tax is minimal. Interest payment that is collected from municipal bonds issued by the federal governments are not taxed at the state or local level, and this makes the municipal bonds attractive to those investors in higher tax brackets.
Investment returns on government bonds are fully taxed at the federal levels but are at the local, and state-level taxes are exempted ( Alexander, 2008) . Also, the gains obtained from redemption or sale of these bonds are taxed.
Risk considerations
The government bonds have a low credit risk among all bond investment s with the most moderate risks. This is because these bonds are usually backed by the government’s credit and full faith. These bonds, however, have market risks if they are sold before their maturity. They also have some inflation risks. The credit risks of the government bonds department not making debt payments as scheduled is unlikely to happen primarily because the government through its powers can issue currencies to make the payments to the bondholders ( Alexander, 2008) . The government bonds are considered to be risk-free virtually.
The municipal bonds fall in the center of the spectrum of credit risk since the risk of default varies depending on the issuer’s creditworthiness, any kind of income stream that funds the bonds, the credibility of the government or reinsurance company and the debt obligation type. The municipalities, unlike the federal government, do not have the power to print and issue currencies hence in the event of default they only issue an IOU hence the credit risk of the municipal bonds is higher compared to that of the government bonds ( Alexander, 2008) .
References
Alexander, C. (2008). Market risk analysis, pricing, hedging, and trading financial instruments (Vol. 3). John Wiley & Sons.
U.S. Financial Data - St. Louis Fed. (n.d.). Retrieved from https://research.stlouisfed.org/datatrends/usfd/
