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Corporate vs. Municipal Bonds: Key Differences

Corporate and municipal bonds play key roles in a portfolio, but be sure to know their differences, similarities, and risks before investing.

October 21, 2024

Corporate and municipal bonds are two types of bonds with unique characteristics and risks. If you are building a diverse bond core, these two types of bonds will likely surface in your research.

Corporate bonds are issued by companies, and municipal bonds are issued by government entities. Each bond has pros and cons and carries specific risks.

Corporate Bonds

Issued by companies to help fuel business expansion, refinance debt, and other capital-raising purposes.

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Municipal Bonds

Issued by states, municipalities, local governments, and cities, largely to fund infrastructure projects.

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What Are Corporate Bonds?

Corporate bonds are bonds issued by companies. Unlike buying shares of a company’s stock and owning equity, investors who buy corporate bonds do not own equity in the company directly. Instead, corporate bondholders will earn interest on the bond and receive their principal at maturity.

Why Do Companies Issue Corporate Bonds?

Companies issue corporate bonds to:

Raise capital for acquisitions
Expand the business
Raise capital to buy back stock
Refinance debt at lower interest rates
Raise capital without issuing equity and diluting shareholders
Diversify their funding sources

Types of Corporate Bonds

The various types of corporate bonds include:

Investment Grade

Investment grade corporate bonds are considered more likely to be paid on time compared to non-investment grade corporate bonds.

Non-investment Grade

Non-investment grade corporate bonds, or high yield bonds, generally offer higher interest rates for the additional risk compared to investment grade.

What Are Municipal Bonds?

Unlike Treasury bonds that are issued at the federal level by the US Treasury, municipal bonds, or “munis,” are issued by government entities including:

Cities
Counties
States
Municipalities

Municipal bonds are similar to Treasury bonds, where bondholders become creditors to the government. If you invest in, or buy, a municipal bond, you are essentially loaning money to the government issuer.

Why Do Governments Issue Municipal Bonds?

Government entities issue municipal bonds to pay for public infrastructure projects — like building roads, highways, or schools. Municipal bond investors will earn their principal investment back plus interest if they hold the bond through maturity and the issuer does not default, similar to other fixed income products.

Less commonly, munis can be issued on behalf of private entities such as non-profit colleges or hospitals.¹

Types of Municipal Bonds

There are two common types of municipal bonds.

General Obligation

General obligation bonds are issued by states, cities, and counties but are not secured by any collateral. General obligation bonds are backed by the issuers’ ability to tax residents to pay bondholders.

Revenue Bonds

Revenue bonds are not backed by taxing power. Instead, this type of municipal bond pays back investors through the revenue the issuer generates from the money raised by selling bonds. An example of this would be using toll revenue that a new highway generates to pay back bondholders.

How These Bonds Pay Interest

Like other fixed income investments, both corporate and municipal bonds can pay investors in a number of ways, including:

Fixed Rate

Fixed rate bonds pay, as the name suggests, a fixed rate of interest. With fixed rate corporates, investors earn the same amount of interest, also known as a coupon payment, regardless of movements in interest rates.

Floating Rate

Interest rates of floating rate, or variable rate, bonds reset periodically. These bonds are subject to movements in interest rates. This means when interest rates move up or down, the interest an investor earns also changes.

Investors may earn interest rates similar to a comparable Treasury bond, plus a little more.²

Zero Coupon

Zero coupon bonds make no interest payments until the bond matures. Instead, investors who hold these bonds to maturity, assuming the issuer can pay back its bondholders, will receive their principal and interest at the maturity date. For example, if an investor buys a zero coupon bond for $1,000 with a face value of $1,200, they will receive $1,200 at the date of maturity.

Compare Corporate Bonds vs. Municipal Bonds

Although municipal bonds tend to have lower yields than corporate bonds, corporate bonds are subject to greater credit risk. A municipality can raise taxes to pay back its bondholders, but corporations cannot. If a company that issued corporate bonds goes bankrupt or cannot pay back bondholders, bondholders may have a claim on assets and cash flows of the company depending on the type of bond.

Here’s a summary of the differences between municipal and corporate bonds.

Figure 1: Compare Municipal and Corporate Bond Characteristics

Characteristic	Corporate Bonds	Municipal Bonds
Issuers	Companies and corporations.	Cities, counties, states, and municipalities. Municipal borrowers sometimes issue bonds on behalf of private entities such as non-profit colleges or hospitals. These are known as conduit borrowers.
Taxes on Earned Interest	Interest income is usually taxable at an investor’s ordinary state and federal income tax rate.	Interest income is generally exempt from federal taxes and can be exempt from local and state taxes.
Risks	Usually riskier than municipal bonds, as companies can go bankrupt. Investors may have a claim to company’s cash flow or assets if the bond is a secured bond, but may not if the bond is unsecured. Companies usually pledge collateral with secured bonds, such as equipment, property, or inventory.	Usually less risky than corporate bonds, since municipal bonds are backed by issuer’s ability to raise taxes to pay back bondholders.
Liquidity	May have higher liquidity than municipal bonds.	May have lower liquidity than corporate bonds.
Yields	Generally offer higher yields than municipal bonds.	Generally offers lower yields than corporate bonds.

Corporate vs. Municipal Bonds: What’s Right for Me?

Consider the pros and cons of both corporate versus municipal bonds.

Benefits of Corporate Bonds

Corporate bonds tend to offer higher yields than Treasury or municipal bonds, making them an attractive option for investors looking to earn income. Corporate bonds also have a low correlation to equities and can help diversify portfolios. Corporate bonds also provide regular income for investors who want to invest with a company, but don’t necessarily want to purchase stock. They also tend to be much more liquid than municipal bonds.

Disadvantages of Corporate Bonds

Despite higher yields, corporate bonds carry a higher risk of default, or credit risk. Additionally, corporate bonds like other bonds are subject to interest rate risks. Companies may not be able to pay back bondholders if they go bankrupt, or if they are unable to generate enough cash to pay back bondholders. High yield bonds, also known as junk bonds, carry a high risk of default but also have higher yields.

Benefits of Municipal Bonds

Municipal bonds are generally more tax efficient than corporate bonds since their interest usually isn’t subject to federal taxes, and is sometimes exempt from state and local taxes. While yields tend to be lower, default risk is also usually much lower than for corporate bonds.

Disadvantages of Municipal Bonds

While defaults are less common for municipal bonds, issuers of municipal bonds can still default. Municipal bonds are also less liquid than corporate and many other types of bonds, which can make it more difficult for an investor to buy and sell them. They also usually don’t offer as attractive yields compared to corporate bonds. Like other bonds, municipal bonds are also subject to interest rate risk.

How Bond Ladders Work

How Bond Ladders Work

A bond ladder is a strategy where an investor purchases a variety of bonds with different maturity dates. This can help investors mitigate interest rate risk. Is a bond ladder right for you?

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Footnotes

Glossary

Bond
A debt investment in which an investor loans money to an entity — typically a corporate or governmental entity — that borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.

Fixed Income
A type of investing, usually involving bills, notes or bonds, for which real return rates or periodic income is received at regular intervals and at reasonably predictable levels. Fixed income can also refer to a budgeting style that is based on fixed pension payments.

Fixed Income Risk
The risk of unexpected changes in a bond’s price due to interest rate changes, credit spread movements or the default of the issuer.

General Obligation Bond
A type of tax-exempt municipal bond that is secured by the full faith and credit of its issuer, typically states, cities, counties, districts and their respective agencies.

High Yield Corporate Bonds
Corporate debt with generally lower credit ratings and higher yields than investment-grade corporate bonds.

Investment-Grade Bonds
Bonds that have a relatively low risk of default. Bond-rating firms, such as Standard & Poor’s, use different lettered descriptions to identify a bond’s credit quality. In S&P’s system, investment-grade credits include those with ‘AAA’ or ‘AA’ ratings (high credit quality), as well as ‘A’ and ‘BBB” (medium credit quality). Anything below this ‘BBB’ rating is considered non-investment grade.

Liquidity
The ability to quickly buy or sell an investment in the market without impacting its price. Trading volume is a primary determinant of liquidity.

Revenue Bond
A type of tax-exempt municipal bond supported by revenue from a specific project, such as a toll bridge, a highway or a local stadium. Revenue bonds are used to finance income-producing projects and are often secured by the projects they finance.

Tax Efficiency
A term that describes various approaches to investing that minimize tax liability. Certain types of investments, including funds like ETFs or securities like municipal bonds are valued for their tax efficiency, as are tax-protected accounts such as Individual Retirement Accounts (IRAs) or Roth IRAs. Also, certain practices, such as tax-loss harvesting, which is designed to lighten tax obligations, are considered ways to pursue greater tax efficiency.

Disclosure

Important Risk Disclosure

Investing involves risk including the risk of loss of principal.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.

All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.

The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.

Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Generally, among asset classes, stocks are more volatile than bonds or short-term instruments. Government bonds and corporate bonds generally have more moderate short-term price fluctuations than stocks, but provide lower potential long-term returns. U.S. Treasury Bills maintain a stable value if held to maturity, but returns are generally only slightly above the inflation rate.

Income exempt from federal income tax may be subject to state or local taxes and the federal alternative minimum tax (AMT). Capital gains may by subject to federal income and other taxes.

High-yield municipal bonds are subject to greater credit risk and are likely to be more sensitive to adverse economic changes or subject to greater risk of loss of income and principal than higher-rated securities.

The municipal market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a debt security to decrease. A portion of the dividends you receive may be subject to federal, state, or local income tax or may be subject to the federal alternative minimum tax.

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