Municipal Bonds

Basically, there are two types of bond yields: current yield and yield to maturity.

• Current yield is the annual return on the dollar amount paid for a bond.
• Yield to maturity is the rate of return you receive by holding a bond until it matures. It equals the interest you receive from the time you purchase the bond until maturity, plus any gain or loss depending on whether the bond’s value has increased or decreased.

Tax-exempt yields are usually stated in terms of yield to maturity, with yield expressed at an annual rate. If you purchase a bond with a 6.0% coupon at par, its yield to maturity is 6.0%. If you pay more than par, the yield to maturity will be lower than the coupon rate. If purchased below par, the bond will have a yield to maturity higher than the coupon rate. When the price of a tax-exempt bond increases above its par value, it is said to be selling at a premium. When the security sells below par value, it is said to be selling at a discount.

The market price of a municipal bond will vary as market conditions (particularly interest rates) change. If you sell your municipal bonds prior to maturity, you will receive the current market price, which may be more or less than the original price depending on prevailing interest rates at the time of sale.  So, for example, a municipal bond issued with a 5.0% coupon will sell at a premium if interest rates at the time of sale are below 5.0% (assuming the risk characteristics of the issuer, i.e. ability to pay, has not changed). Consequently, it is important to understand that municipal bond prices fluctuate in response to changing interest rates: prices increase when interest rates decline, and prices decline when interest rates rise.

It’s easy to understand the reasons:

• When interest rates fall, new issues come to market with lower yields than older securities, making the older securities worth more, thus the bond price will increase.
• When interest rates rise, new issues come to market with higher yields than older securities, making the older ones worth less, thus the bond price will decline.

Interest payments:  Usually, interest on a long-term bond is paid semi-annually, while interest on short-term notes is paid at maturity.

Form of issuance:  Municipal bonds are issued in registered form only, which means that the investor’s name is registered on the issuer’s, or its agents’, books. Virtually all municipal bonds today are issued in “book-entry” form, in which an investor’s ownership is recorded through data entry at a central clearinghouse. In addition, the bank or investment firm will provide the investor with a confirmation that is a written record of the transaction. With book-entry securities, physical transfer of certificates is not necessary. Registered and book-entry bonds offer a number of protections and conveniences to bondholders, including protection from loss or theft, automatic payment of interest, notification of calls and ease of transfer.

Minimum investment. Most municipal notes and bonds are issued in minimum denominations of $5,000 or multiples of $5,000.

Payment terms. Dealers are required by the Securities and Exchange Commission to receive payment for a securities purchase and to make payment for a securities sale before the third business day following the date of the trade.

Marketability. Holders of municipal securities can sell their notes or bonds through one of the many banks and securities dealer firms that are registered to buy and sell municipal securities such as StateTrust.

Reporting requirements. All tax-exempt interest must be reported on tax returns. This is simply a reporting requirement and does not affect the tax-exempt status of the security.*

What are the costs of investing in municipal bonds? Municipal securities are bought and sold between dealers and investors much like other debt instruments. The price an investor pays for a municipal security includes a dealer’s own spread, or profit, on the transaction.