Municipal bond prices moved lower during the second quarter, as fears about the Federal Reserve tapering its stimulus program rattled the financial markets. While a handful of states still face some budget pressure for the remainder of their 2013 fiscal year, 45 states reported that they are likely to meet or exceed their revenue projections for fiscal year 2013. Interest-rate volatility and the longer term prospect of higher rates have reinforced our bias toward a more limited duration stance. We continue to overweight essential-service revenue bonds, as well as the A-rated and BBB-rated segments of the market. Our outlook calls for defaults to remain low and continued gradual economic recovery.

1. PUTNAM INVESTMENTS | putnam.com
Key takeaways
•Municipal bond prices moved lower during the second quarter, as fears about the
Federal Reserve tapering its stimulus program rattled the financial markets.
•While a handful of states still face some budget pressure for the remainder of their
2013 fiscal year, 45 states reported that they are likely to meet or exceed their
revenue projections for fiscal year 2013.
•Interest-rate volatility and the longer-term prospect of higher rates have
reinforced our bias toward a more limited duration stance.
•We continue to overweight essential-service revenue bonds, as well as the A-rated
and BBB-rated segments of the market.
•Our outlook calls for defaults to remain low and continued gradual economic
recovery.
Economic growth, interest-rate volatility, and federal budget cuts
created a complex environment during the second quarter. How did
the municipal bond market perform?
Heightened uncertainty on many fronts contributed to a mixed picture for the
municipal bond market. During April, the municipal bond market followed the
Treasury market to some extent, and benefited as rates moved lower and prices
moved higher. However, in a notable sell-off from May into June, those gains were
erased for the municipal market along with most fixed-income asset classes.
Continued improvement in the U.S. economy raised concerns about the Federal
Reserve paring back its stimulative bond-buying program, known as quantita-
tive easing [QE]. Consequently, interest rates rose sharply, with the yield on the
10-year Treasury bond soaring close to 100 basis points, or a full percentage point,
since the beginning of May.
In June, technical pressures in the municipal market compounded the sell-off.
Faced with the prospect of higher interest rates, many retail investors sold their
municipal bond investments. Consequently, municipal bond funds experienced
outflows that put further downward pressure on this asset class. On a positive
note, with investor fears subsiding by period-end, June 27 marked one of the
biggest one-day rallies in long-term municipal bonds since October 2008.
Q2 | 2013 » Putnam municipal bond funds Q&A
Rising bond yields
outweighed progress in
state finances, tax clarity
Portfolio Managers
Thalia Meehan, CFA
(industry since 1983)
Paul M. Drury, CFA
(industry since 1989)
Susan A. McCormack, CFA
(industry since 1986)

2. Q2 2013 | Rising bond yields outweighed progress in state finances, tax clarity
PUTNAM INVESTMENTS | putnam.com 2
Despite volatility in the second quarter, we continue
to see some encouraging trends across the municipal
bond market. Refinancing activity has been high,
as many issuers are retiring higher-coupon bonds
whenever possible and replacing them with lower-
yielding debt. While this trend makes it difficult to add
higher-yielding securities to the portfolio, refinancing
activity has simultaneously helped buoy prices and
demand — seasonal weakness notwithstanding — and
this has been true particularly for more seasoned, or
mature, bonds with coupons above today’s prevailing
rates. In addition, increased clarity on tax rates, at least
for the near future, has had a positive influence on
the market.
Why did the markets react so strongly to the
Fed’s statements?
In early May, the Fed released a statement announcing
that the central bank might consider reducing the
amount of Treasuries and mortgage debt that it buys
as part of its bond-buying program. This monetary
stimulus program was designed to hold interest
rates low to encourage employment and boost
economic growth. However, the announcement,
which also included a more upbeat assessment of
the economy by the Fed, drove interest rates higher
in anticipation of the Fed winding down the asset
purchases. Initially, the municipal bond market
withstood the rise in Treasury rates, but eventually
municipal bond investors became nervous, and
municipal yields moved higher as prices declined.
More recently, at the June 19 Federal Open Market
Committee meeting, Chairman Bernanke’s comments
clarified that if the optimistic view of the economy’s
progress proves to be correct, then a “tapering” of
bond purchases may begin somewhat sooner than
had been widely expected. While the Chairman was
careful to stress that the Fed’s actions will be driven
by the progress made by the economy, his remarks
were widely seen as hawkish and led to a further rise in
interest rates. Consequently, Treasury and municipal
bond rates continued their sell-off before fears began to
subside by quarter-end.
How did sequestration and related legislation
impact the municipal bond market?
On March 1, 2013, the federal budget sequestration
went into effect as part of January’s American Taxpayer
Relief Act. While the political rhetoric associated with
those cuts often has painted them as catastrophic, we
believe any fallout for most states will be fairly benign.
In our view, the cuts certainly won’t be beneficial for
states and local communities, but their impact will be
staggered over time. Thus, while we believe widespread
negative effects are unlikely, isolated budget or insol-
vency issues may create some headline risk. Sectors and
localities that benefit most from federal support and
areas that are heavily reliant on defense spending are
the most vulnerable, in our opinion. But at this point, it is
difficult to quantify exactly how sequestration will affect
states’ finances. The ultimate impact will depend on
how well these states have prepared and budgeted for
the sequestration cuts.
Outside of the sequestration issue, how are
states’ finances faring today?
Across the nation, states continue to make slow but
steady progress as they emerge from the Great Reces-
sion. While a handful of states still face some budget
pressure for the remainder of their 2013 fiscal year, 45
states reported that they are likely to meet or exceed
their revenue projections for fiscal year 2013, according
to the National Conference of State Legislatures. While
we believe this is an encouraging trend, challenges
remain at the local level given federal deficit reduction
and the ensuing cutbacks to the states. Many states
have lowered expenses by reducing their financial
support to cities and counties. Should the economy
begin to slow, this reduced spending would almost
certainly negatively affect municipal finances, in our
opinion. However, on balance, we think the outlook
is becoming increasingly stable, given the general
improvement in employment, economic growth, and
consumer confidence, all of which have contributed to
rising tax collections.

3. Q2 2013 | Rising bond yields outweighed progress in state finances, tax clarity
PUTNAM INVESTMENTS | putnam.com 3
It is important to keep in mind that general obligation
bonds, which are backed by the general credit and
taxing power of state and local municipalities, compose
approximately one third of the overall municipal
market, while two thirds are revenue bonds. Generally
speaking, we feel that revenue credits, which are
typically issued by state and local governments to
finance a specific revenue-generating project, are
faring well. Among revenue bonds, we continue to see
opportunities in sectors such as higher education, utility,
and health-care bonds.
How would you describe the general health
of the municipal bond market?
For calendar year 2012, bankruptcy filings represented
approximately 0.12% of the $3.7 trillion municipal
bond market. This default rate is in line with historical
averages, and we do not believe defaults will increase
meaningfully in the near future. We do expect to see
occasional isolated incidents of insolvency, however,
which can create headline risk. For example, in Michigan
a fiscal emergency was recently declared in Detroit,
which has been in financial distress for some time now,
and Puerto Rico was downgraded by Moody’s and
Standard & Poor’s. The government of Puerto Rico
has since put in proposals for pension reform in an
attempt to mend its credit profile. We are also closely
monitoring the outcome of the bankruptcy proceedings
in Stockton, California. That city filed for bankruptcy
protection last summer, and the eventual outcome of
the legal proceedings, with bondholders on one side
and pension funds on the other, may set a precedent
in the market, and could impact how other distressed
cities negotiate with creditors.
How did you position the funds during
the quarter?
As has been our strategy for some time, we continued to
favor essential service revenue bonds over local general
obligation bonds. From a credit-quality perspective, the
A-rated and BBB-rated segments of the curve continue
to offer attractive relative value opportunities, in our
analysis. In terms of maturities, we find 10 to 20 years
to be the optimal part of the yield curve in today’s envi-
ronment. We continue to have a favorable outlook and
have overweighted investments relative to the funds’
benchmark in several sectors of the municipal bond
market, including continuing-care retirement communi-
ties, utilities, and higher education. Generally speaking,
the supply/demand picture becomes more favorable
in the summer months when reinvestment demand is
typically the highest of the year — thereby providing
support for municipal bond prices. That said, other
factors such as interest rates and the direction of the
economy have and could continue to influence market
activity. If we see a technical imbalance, we believe that
our positioning should allow us to take advantage of any
dislocations in the market.
What is your outlook?
We continue to have a constructive outlook for munic-
ipal bonds, though we believe that returns in 2013 will be
less about price appreciation and more about coupon
income in the tax-exempt market. While the spreads
are much narrower than they were at their peak, they
remain attractive within certain credit-quality areas,
in our opinion. Although they softened somewhat at
the end of the period, technical factors in the market —
specifically, continued refunding activity and stable
investor demand — generally have remained supportive
in recent months. While investors now have more
near-term certainty on tax rates for 2013, many issues
remain unresolved, including federal budget sequestra-
tion, the debt ceiling, and the potential for broader tax
reform later this year, all of which could affect the value
of municipal bonds. As always, we are monitoring the
situation closely and positioning the funds accordingly,
based on our analysis.

4. Q2 2013 | Rising bond yields outweighed progress in state finances, tax clarity
The views and opinions expressed here are those of the portfolio managers as of June 30, 2013, are subject to change
with market conditions, and are not meant as investment advice.
Consider these risks before investing: Capital gains, if any, are taxed at the federal and, in most cases, state levels.
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reasons, including general financial market conditions and factors related to a specific issuer or industry. You can lose
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Annualized total return performance as of June 30, 2013
Putnam Tax Exempt Income Fund (PTAEX)
Class A shares
(inception
12/31/76)
Before
sales
charge
After
sales
charge
Barclays
Municipal
Bond Index
Last quarter -3.40% -7.26% -2.97%
1 year 0.12 -3.88 0.24
3 years 4.82 3.40 4.46
5 years 5.03 4.18 5.33
10 years 4.10 3.67 4.42
Life of fund 6.70 6.58 —
Total expense ratio: 0.75%
Putnam Tax-Free High Yield Fund (PTHAX)
Class A shares
(inception
9/20/93)
Before
sales
charge
After
sales
charge
Barclays
Municipal
Bond Index
Last quarter -3.97% -7.81% -2.97%
1 year 1.57 -2.49 0.24
3 years 6.33 4.89 4.46
5 years 5.62 4.76 5.33
10 years 4.83 4.40 4.42
Life of fund 6.20 6.04 6.92
Total expense ratio: 0.82%
Returns for periods less than one year are not annualized.
Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
Share price, principal value, and return will vary, and you may have a gain or a loss when you sell your shares. Performance
of class A shares after sales charge assumes reinvestment of distributions and does not account for taxes. After-sales-
charge returns reflect a maximum 4.00% load. For purchases made after June 24, 2013, the 1% short-term trading fee, as
described in the fund's prospectus, no longer applies. For Putnam Tax-Free High Yield Fund, the life-of-fund performance
for class A shares is based on the historical performance of class B shares (inception 9/9/85), adjusted for the applicable
sales charge. To obtain the most recent month-end performance, visit putnam.com. The funds’ expense ratios are based
on the most recent prospectus and are subject to change.
The Barclays Municipal Bond Index is an unmanaged index of long-term fixed-rate investment-grade tax-exempt bonds.
It is not possible to invest directly in an index.