Municipal Bonds Vs. Money Market Funds

There are various types of investment opportunities which an investor can choose from. Governments also provide options through which they can meet their funds need. Municipal Bonds are the debt securities the government issues to meet the capital expenditure needs of the local government. Both have different maturity periods. Let us look at both of these types of investment options. 

What are municipal bonds?

Municipal Bonds are known as ‘Munis’ or ‘Muni Bonds’. Municipal Bonds are debt-securities issued by a municipal corporation or associations, generally Non-profit Organizations (NPO), to local governments with the purpose of  fulfilling their fund requirements needed for constructing schools, hospitals, highways etc. Municipal bonds have existed in India since the year 1997. Bangalore Municipal Corporation is the first urban local body to issue municipal bonds in India. These bonds are issued for a fixed maturity period and the investor earns a fixed interest rate on them. 

Need for Municipal Bonds

Municipal Bonds are issued to the local government when they need to raise funds for projects such as – 

• Roads
• Infrastructure
• Constructions
• Airport
• Bridges
• Hospitals, etc.

Advantages of Municipal Bonds

Rated Bonds- Municipal Bonds must have a rating which is above the minimum investment grade. The rating must be from an authorized rating agency such as CRISIL, ICRA, CARE Ratings etc. So, the investors can trust the authenticity of these bonds. 

Minimal Risk- Since the approved authorities and municipal corporations issue municipal bonds so these bonds have minimal risk of investments. 

Tax-free- In India, interest on municipal bonds is generally exempt from taxes. Thus, it attracts investors. 

Disadvantages of Municipal Bonds

Less returns- Municipal bonds offer a low rate of return in comparison to other market instruments available. 

Long Maturity- Municipal bonds have a long maturity period. The investors are locked in for around 3 years in such bonds. Thus, these bonds are less preferable. 

Types of Municipal Bonds

The two most common types of municipal bonds are- 

General Obligation Bonds- General obligation Bonds are municipal bonds issued by municipal corporations and associations to the local government for general projects such as the infrastructure of a region etc. The interest on these bonds and the bond repayments can be processed through income generated from any of the projects and taxes. 

Revenue Bonds- Revenue Bonds are the bonds issued by municipal corporations and associations to fulfill their fund requirement for a particular project such as a commercial park, building etc. The interest on these bonds and the bond repayments can be processed only from the income generated from the said project for which the bond was issued. 

SEBI guidelines to Municipal Bonds 

From the year 2015, the Securities and Exchange Board of India(SEBI) has provided certain guidelines in the issuance of these bonds- 

• The issuing corporation or associations should not come in the list of ‘willful defaulters’ published by the Reserve Bank of India. 
• The issuing corporation or associations should not default in repayment of loan repayments acquired from the Banks and  financial institutions in the past years. 
• The issuing corporation or associations should not have a negative net worth in the preceding three years from the date of issuance of the bonds. 

What are Money Market Funds

Money market is a market for short-term securities. Money Market Funds (MMF) deal in those securities which have a short-term maturity period of up to 1 year. These types of mutual funds deal in short-term and highly liquid debt securities. Money market funds are also called money market mutual funds.

Advantages of Money Market Funds

High liquidity- Money market funds are highly liquid in nature. They can mature within 1 year.   

Shorter maturity- Due to its short-term maturity period, money market funds are subject to less interest rate risk. 

Less volatile- Money market funds are less volatile as compared to other mutual fund investments. Hence, they are generally stable in nature. 

Disadvantages of money market funds

Low Returns- Money market funds offer low returns. In cases of rising inflation, it may not be able to beat inflation. 

Declining purchasing power- Due to lesser returns, rising inflation and tolling expenses, the purchasing power of the investor declines. 

Types of Money market funds

Few types of money market funds are- 

Treasury bills- T-bills or Treasury Bills are one of the oldest money market instruments that the RBI issues on behalf of the Central government for raising funds. They are issued for a period of up to 1 year. These bonds are issued at discount and redeemed at face value. These are safest instruments as they involve zero risk of default in investments. 

Commercial Papers- Commercial papers are such promissory notes issued by big enterprises to raise capital from investors to fulfill their business needs. They can be matured within 7 days to 270 days. 

Certificates of Deposits (CDs)- Certificates of Deposits are short-term money market instruments issued by the banks and financial companies having a fixed interest rate on it. CDs are issued for a large amount of money (1 lakh or in multiple thereafter.) They can be matured within 7 days to 1 year. 

Common risks involved in municipal bonds and money market funds

Interest Rate Risk– Municipal bonds and money market funds are subject to interest rate risks. Any changes in interest rate will affect the market price of the bonds. If the interest rate rises, the bond’s market price declines and vice-versa. Also, longer maturity bonds are subject to more changes in interest rates, hence, loss of income to the investors. 

Call Risk– Call risk arises when the investor demands for premature repayment of the bond due to declining interest rates. This risk will not arise if the interest rates are rising. So before investing, the investors should check the bond’s call provisions. 

Inflation Risk- Inflation refers to the rise in the prices of  goods and services or the upward movement in prices. Due to inflation, the investor’s purchasing power declines, creating a risk of high interest rates and low market value of the bonds. 

Liquidity risk- Liquidity risk arises due to volatile markets. It can also generate due to lack of liquidity in a particular security.

Comparing Municipal Bonds and Money Market Funds

Final Words

Municipal bonds are long term debt securities issued by municipal corporations to the local government to meet their capital needs. On the other hand, Money Market Funds are a type of the Mutual funds which RBI issues on behalf of the central government to meet the working capital requirements. They have a shorter maturity period and can be matured within 1 year. While comparing the two, both have their own advantages and disadvantages and both involve some or the other kind of risks associated with them. The investor can choose between the two in accordance with their need for investments, return rates, risk of investing, tax on gains and other factors.  

Frequently Asked Questions