Municipal Bond Forum
Determining outstanding value
Q
In an e-mail to me, you recommended a “AA”-rated premium bond maturing in 2043 and callable in 2020, with a yield-to-call of 2.60%. You said it represented “outstanding value.” I don’t agree. We’re in a 3.30% market for that quality of bond, and it’s almost certain to be called on its call date in five years unless interest rates rise dramatically.
A
James A. Klotz responds:
We agree, this is a 3.30% market, and we are sure you’re aware this rate applies to “AA” quality bonds with 30-year maturities, whereas the rate on similar quality five-year bonds would be approximately 1.50%.
If the bonds you were offered were to be called in 2020, it would result in a 2.60% yield, providing 73% more yield and income than a bond due in five years.
If the bonds are not called, the yield to maturity will be 4.22%, which provides 28% more yield and income than the 3.30% par bond to which you refer in your e-mail.
When a bond yields 1.10 basis points more to the call date and 92 basis points more to maturity than can be purchased on comparable quality bonds in the new issue market, we consider that to be a win-win situation and an outstanding value.
We can’t be as certain as you that these bonds will be called in five years. Forty years of experience in this market has taught us to refrain from predicting interest rates. As municipal bond specialists, our efforts are geared to design the most sensible approach to either scenario.
We don’t know many people who, five years ago, thought interest rates would be where they are today.
Start here.
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The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.