eli5: How do municipal bonds work?


eli5: My town is using bonds to pay for a public library remodel. How do bonds work?

In: Economics

A municipality wants to spend a bunch of money that they don’t have. So they issue bonds. People buy the bonds and the municipality gets a big hunk of money. The municipality promises to pay back the bonds over time, with a guaranteed interest on top of it. So the investors eventually get back the money they paid for the bonds, plus profit (the interest).

It’s a good deal for the municipality, since they get the money they needed right away. It’s a good deal for the investors, since they get an almost-guaranteed rate of return for their investment. And sometimes the gains that they make are also tax-free, which makes the profit even more valuable.

Like anything else, it’s not 100% risk-free for the investors. If the municipality runs into financial problems in the future, they could default on their bond payments and the investors can get screwed. Municipalities try very hard to avoid this, since they’ll have a hard time selling bonds ever again if it happens. They’ll have to pay a much higher interest rate, too.