Over the past month, I've been getting a lot of questions from clients regarding specific credit events in the municipal bond market. Recent credit downgrades and bankruptcies clearly have some muni investors on edge.

The past few months have certainly been a bit of a roller coaster ride for the municipal market. In December, I wrote about the fear of a potential loss of the tax-exempt status of municipal bonds, which drove a sell-off in the muni market. After the Fiscal Cliff was resolved and it was clear munis would remain exempt from federal taxes, investors flocked back to the sector and bond prices rose. Then in March we saw another pullback, potentially driven by high net worth investors selling their munis and using the proceeds to pay 2012 tax bills.

On top of all of this is news about the credit worthiness of specific municipal issuers.

Detroit has been buckling under the weight of its deteriorating finances for sometime now. And with places like Harrisburg in Pennsylvania, Stockton and San Bernardino in California and Jefferson County in Alabama having filed for bankruptcy over the last few years, it is reasonable to wonder whether the major city of Detroit may ultimately be next. With the takeover of the city by the state of Michigan now imminent, it is also reasonable to contemplate the direct exposure to Detroit in your municipal bond portfolio and the potential implications of its ongoing problems on your muni investments.

In order to explore the question about direct exposure to Detroit, we will examine the iShares S&P National Municipal Bond Fund (MUB), which is by far the largest national municipal bond ETF with $3.6 billion in assets. Overall, this product has a total of 2,332 holdings as of Tuesday. Of these securities, only

By Timothy Strauts

Municipal bonds had another good year in 2012 as interest rates continued to fall and, despite making a number of high profile headlines, municipal bankruptcies were contained. With interest rates on municipal bonds at 45-year lows, what can investors expect in 2013?

Fiscal Cliff
The "Fiscal Cliff" compromise answered the question as to whether interest on municipal bonds would be taxed in 2013. Municipal bonds avoided all the various proposals to eliminate or reduce their tax exemption. In fact, the increase in the top income tax rate to 39.6% from 35.0% may make tax-free municipals more attractive for some high income investors. After a sell-off in December the municipal market has rallied as investors have shaken off concerns about potential changes to muni bonds' tax treatment in the near term. But the tax status of municipal bonds is far from resolved in Congress.

Credit Quality