municipal bonds

state and local government issue municipal bonds to obtain long-term funds for such things as highways and schools. the interest payments holders of these bonds receive are exempt from federal income tax (although some state and local governments do collect income tax on municipal bond interest earnings). this makes municipal bonds an attractive investment for lenders in high-income tax brackets.
for example, a person in a 36 percent tax bracket earning 10 percent taxable interest gets to keep only 6.4 percent after tax. A tax-free municipal bond paying 6.5 percent or more would be an attractive investment in this case. A secondary market exists for municipal bonds issued by large cities and states, but it is less active than the corporate and federal government bond markets. the bonds issued by smaller municipalities do not trade on a secondary market, which makes it very difficult for a holder to liquidate a bond prior to maturity .