Bonds issued by a government agency that purchases U.S. government securities to pledge as collateral for the bond issue. Pre-funded bonds are issued by municipalities that wish to attain a higher credit rating for their debt. Since state-issued bonds are not pledged by the full faith of the U.S government, the underlying collateral minimizes the risk of default. The pre-funded bond and the U.S. securities tend to have the same maturity. 



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Pre-funded bonds provide the tax advantages present in regular municipal bonds, but are exposed to less risks. The federal government-based collateral reduces the potential for the issuer's credit to deteriorate.