This is a clear and concise definition of tax-exempt bond from Wikipedia:
A tax-exempt bond or municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds include cities, counties, redevelopment agencies, special-purpose districts, school districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds may be general obligations of the issuer or secured by specified revenues. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.
In essence, the tax exempt bonds are similar to conventional loans. The borrower has to pay the principal amount plus the interest. To get the tax-exempt bond, you must show your worth by demonstrating a good business plan and project proposal.