What distinguishes municipal bonds from corporate bonds?

Municipal bonds are primarily distinguished from corporate bonds by their tax-exempt status on interest income. When investors hold municipal bonds, the interest earned is often exempt from federal income tax and sometimes state and local taxes as well, depending on the investor's residence and the bond's origin. This tax advantage makes municipal bonds particularly appealing to investors who are in higher tax brackets, as the after-tax return can be significantly higher than the equivalent return from taxable corporate bonds.

This attribute sets municipal bonds apart in the fixed-income market, as it directly impacts the yield an investor would require for holding such debt. Investors might be willing to accept a lower yield on a municipal bond compared to a corporate bond, due to the tax benefits associated with the municipal issue. Understanding this tax treatment is crucial for assessing the true value and return on investment of fixed-income securities.

Other options do not accurately capture the essential differences. For instance, municipal bonds are not issued by international corporations, nor can it be universally stated that corporate bonds have longer maturities or that municipal bonds inherently have higher credit risk; each bond's credit risk depends on various factors, including the issuer's creditworthiness.