Question

Municipal bonds: a. are totally risk-free. b. generally have higher coupon rates than corporate bonds. c. pay interest that is federally tax-free. d. are rarely callable. e. are free of default-risk.

1) are totally risk-free.
2) generally have higher coupon rates than corporate bonds.
3) pay interest that is federally tax-free.
4) are rarely callable.
5) are free of default-risk.

Answer 1

Municipal bonds pay interest that is federally tax-free, although they carry some risk and are not guaranteed to be default-risk free or uncalled. Corporate bonds typically offer higher coupon rates to compensate for their higher perceived risk compared to government issues. Thus, the option 3 is the correct answer.

Step-by-step explanation:

The question asks about the characteristics of municipal bonds. The correct answer is that municipal bonds pay interest that is federally tax-free. Unlike the statement that they are totally risk-free or free of default risk, municipal bonds, like all securities, do carry some risk. While they are generally considered safer than many other types of bonds and are less likely to be called before maturity, they are not completely without default risk. Corporate bonds usually have higher coupon rates than municipal bonds because corporate issuers are typically seen as riskier compared to state or local governments. This risk is also why corporate bonds tend to offer higher yields as compensation.