A Foundation of Quality
Tax-exempt income... predictability... a solid financial foundation. Combined, these characteristics exemplify municipal bonds. Since the establishment of the federal income tax in 1913, all types of investors have purchased municipal bonds for their tax savings and conservative investment quality.

Municipal Bonds–What are they?
Municipal bonds are tax-exempt, fixed income securities that allow individuals the opportunity to participate in the development or maintenance of a variety of shared public interests, such as schools, highways, hospitals, bridges or other public facilities. When you purchase a municipal bond, you are lending money to an issuer (a state or local government entity) for a specified period of time and for use on a specific public project. The issuer promises to repay your principal in full at the bond’s maturity, in addition to paying you interest income—which is tax-exempt.

The widespread appeal of municipal bonds is demonstrated by the fact that the majority of them are held by individual investors. The following are several reasons why municipals can be an attractive and solid investment.

Tax-Exempt Income
The most important benefit of municipal bonds is that the interest they earn is free from regular federal income taxes. Often, the interest is exempt from state and local income taxes as well.

High Credit Quality
Municipal bonds have an outstanding record for meeting principal and interest payments on time. They are second only to U.S. Government/Agency debt obligations in investment quality.

Adaptability
There are many municipal bond maturities to help you meet your investment objectives. Maturity dates on municipals range from weeks to 30 years or more, allowing you to custom tailor your portfolio to meet specific needs.

Diversification
The municipal bond market is one of the most diverse fixed income markets in terms of investment quality, maturity, type of bond and geographical location.

The advantage of investing in tax-exempt municipal bonds is best understood by comparing what a taxable investment would have to yield in order to match the tax-exempt returns offered by municipal bonds on a taxable equivalent basis. The chart below shows tax-exempt yields ranging from 3.00% to 5.50%, and illustrates the pre-tax yield a taxable bond would have to offer in order to match the tax-exempt returns. This chart is for illustrative purposes only and does not represent any specific security.

Generally, the interest payments on tax-exempt municipals are lower than taxable investments with the same credit quality and maturity. However, because the federal government does not tax the interest you earn from municipals, typically you may receive more spendable income from a tax-exempt bond than from a taxable bond.

Consider the following example:
Mr. Abbott, Ms. Brown and Mr. Cooke each have $100,000 available for investment in high quality, market-name securities. Essentially, these are the characteristics of high quality bonds. Each investor had equity and other asset holdings.

Potential fixed income alternatives include a 20-year maturity "Aa"-rated municipal bond yielding 5.00% and a similarly rated long-term corporate bond offering a return of 6.50%. As par-priced securities, the bonds would earn annual income of $5,000 (tax-exempt) and $6,500 (taxable) per year, respectively.

• Mr. Abbott has a taxable joint-return income of $112,000 and incurs a maximum tax rate of 25% (a).
• Ms. Brown’s taxable joint-return income is $170,000 on which the maximum tax rate is 28% (b).
• Mr. Cooke’s taxable joint-return income is $300,000, which incurs a maximum incremental rate of 30% (c).

The value of the taxable corporate bond’s annual income for each investor is calculated as seen in the preceding table. Each investor would realize $5,000 in income from the tax-exempt bond. Mr. Abbott would be better off investing in the municipal investment, since his net return would be $4680 vs. $5000 from the tax-exempt bond. Ms. Brown’s tax-exempt return of $5,000 marks the municipal bond as a better choice than the corporate bond, with its net return of $4,355. The municipal is even more attractive for Mr. Cooke, since the taxable alternative nets only $4,225, after taxes.

The 2003 Federal Income Tax table is another way for each investor to look at the relative value of tax-exempt investment. For Ms. Brown, a better return than 5.00% tax-exempt (33% bracket) would require a taxable bond yielding more than 7.46%; for Mr. Cooke, the taxable bond’s yield would have to exceed 7.69%. To attain such levels- if indeed it is possible to attain such levels on an investment quality security- may require lowering quality standards or extending maturities on the taxable bond purchase.

This information concerns the tax-exempt interest income generated by municipal bonds. If bonds are sold prior to maturity, prices may be higher or lower than the original purchase price and actual yields may be higher or lower than the yields stated when the original investment was made. Insurance applies only to the prompt payment of interest and principal and does not apply to yield quotations or market values, which will fluctuate over the life of the bonds. Interest income from some municipal bonds may be subject to the “Alternative Minimum Tax” (AMT). Investors are also urged to consult their own tax advisors with regard to their specific situation prior to making any investment decisions with tax consequences.