What advantage do tax-exempt bonds offer?

Tax-exempt bonds provide the notable advantage of having their interest exempt from federal income taxes under specific conditions. This means that investors who purchase these bonds do not have to pay federal taxes on the interest income generated, allowing them to keep a larger portion of their returns. This tax exemption can make tax-exempt bonds an attractive investment option, especially for individuals in higher tax brackets who seek to minimize their taxable income.

Additionally, certain types of tax-exempt bonds, such as those issued by state and local governments, may also offer state tax exemptions, depending on the investor's state of residence. The appeal of tax-exempt bonds is heightened during periods of rising tax rates, as the relative value of the tax-free interest becomes more pronounced, ultimately enhancing the after-tax return for the holder.

The other options do not accurately describe the primary benefits of tax-exempt bonds. Options discussing taxable interest and guarantees on rates or principal value mischaracterize the nature and characteristics that set tax-exempt bonds apart in the investment landscape.