Muni bonds is the colloquial term for municipal bonds, which are credit instruments offered by cities, states, counties and other government entities smaller than the federal level for use in capital expenditure projects, such as the building of roads, schools and hospitals.

Muni bonds stand out for their federal tax exemption, and their exemption from most state and municipal taxation, which makes them particularly attractive to large investors and institutions that would otherwise face significant capital gains taxation.

Municipal Bond Valuation

Muni bonds are generally considered to feature a low counterparty risk, higher than that of most federal government bonds yet lower than the risk for bonds issued by corporations.

Therefore, muni bond valuation is often focused on the applicable taxation terms, which can vary significantly across muni bonds, and even across different bonds from the same issuer.

Where the counterparty risk to muni bonds does become significant is when the repayment terms are tied to the success of the specific capital project that they are intended to fund.

In these cases, the muni bonds are not issued by the city, state or county as a fiscal entity, but rather they are issued through the municipal entity yet tied to a specific capital project.

Therefore, muni bonds tied to a water treatment plant, for example, will tend to face a lower counterparty risk compared to muni bonds tied to the revenues from a municipal park.

That said, while muni bond defaults were once largely unheard of, their frequency has increased over the last few decades, and muni bonds are no longer considered to be the perfectly safe investments that they once were.

Muni Bonds and Trading

Day traders will find that muni bonds generally offer very stable price action, with few opportunities to employ traditional day trading strategies.

However, the increasing number of muni bond defaults and default scares, though still rare, has brought some life to the muni bond markets in terms of day trading opportunities.

The advantage of this situation for day traders is that it is comparatively easy to identify the small number of muni bonds that will demonstrate the kind of price action that lends itself to day trading strategies.

Furthermore, the market for these muni bonds is likely to be illiquid and free of may other speculators, meaning that day traders will be able to operate with relative impunity when trading these muni bonds.

Day traders will find that trading in muni bonds is a mixture of traditional bond trading and trading in the market for small cap stocks, and experience in one or both of these areas will be useful when day trading muni bonds.

Final Thoughts

Muni bonds have their own features that separate them from other kinds of bonds and make their valuation unique.

Day traders who are able to grasp the nuances of muni bond valuation will find a market that is limited yet largely untapped by other speculative investors.

Day traders are encouraged to familiarize themselves with general bond market trading and trading in the market for small cap equities to get a feel for what muni bond trading is like.