FMSbonds, Inc.’s Municipal Bond Forum is an exclusive opportunity for investors to submit questions and comments on the bond market or to respond to one of our articles.
To participate, just send us an e-mail. Be sure to include your name or initials and your state of residence. Posted e-mails may be edited for length and clarity. If you prefer a private response, please note that in your e-mail. Responses are provided by James A. Klotz, president and co-founder of FMSbonds, Inc., a municipal bond specialist for more than 35 years, and other members of the firm as noted.
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How will the potential hedging of the tender-option-bond-programs, or unraveling of these trades, affect the value of AAA-rated insured bonds? Will this seriously harm bond values and is it a transitory effect?
D.M., New Jersey
In your article “Hidden Gems in the Muni Market”, you state that a premium bond will produce about 50 basis points more yield than a comparable par bond maturing in the same year. However, as I see it, and what you don’t say, is that the 50 extra basis points comes from the premium that was paid in that, when the bond is called (at par or for less than the premium paid) or matures, the premium disappears or dissipates. In other words, I am merely trading some return of capital for more current income. It’s like taking the premium from the right hand and putting it in the left hand and calling it “additional yield.” Please convince me that I am making money by collecting less than I paid when I sell a bond or when it is called or matures at 100 when I paid, say, 105. As I see it, I am merely increasing my own current income with my own money taken from (by reducing) the premium part of the price that I paid for the bond. Is that why, as I understand it, the IRS does not allow a capital loss (of the lessened premium) to be deducted on my income tax because the so-called “loss” is really transformed into “current income” and, therefore, merely changes its nomenclature – not its value?
L.K., Maryland
I recently had a stockbroker buy a few hundred thousand dollars of munis with a duration of 20 to 30 years, shortly after I saw the bond market fall and the value lost was $25,000 if these munis were sold today! A few quick questions: 1) How often are bonds of 20 to 30 years called before maturing? 2) If interest rates go up, then bond values will go down? 3) If the stock market crashed tomorrow, would the value of these muni bonds increase immediately?
J.L., Nevada
I’m having trouble following your logic. Would you make clearer what is happening to the markets?
How do you determine which bonds that are at depressed levels? It seems to me that it would take a team of experts led by Bill Gross to determine the truth from the trash.
D.J., New York M.G., California
I am a client of yours who has purchased several insured bonds. Could you explain whether and, if so, to what extent, these insurers will be negatively impacted by the collapse of the sub-prime market where, apparently, several of them provided insurance on junk paper? Will they remain capable of handling any muni defaults individually or as a group?
T.B., Georgia
Am I missing something? By purchasing a bond as an individual investor, you say that I am helping the states, not the tobacco industry. Wouldn’t it be more accurate to state that I am helping the investment banks, who bought the stream-of-payments from the states, so that those banks spread their risk of loss to individuals like me? If no individual bought a bond, wouldn’t the investment banks a) get all the income, but also b) incur all the risk of default?
K.K., West Virginia
I just discovered your site and find it very interesting. But with regard to your “Lessons in Laddering” article, my understanding is that accreted market discount is taxable at ordinary income rates when a bond is sold, even for municipal bonds. In your example, when the discounted bonds bought in the swap at 50 mature at 100, ordinary income tax will be owed on the $100,000 gain. Therefore the tax loss of $100,000 resulting from the swap will be offset by $100,000 of accreted market discount at maturity. If the tax loss is used to offset capital gains, then the investor is only saving 15% ($15,000) in taxes at the time of the swap, but will owe anywhere up to 35% ($35,000) taxes on the accreted market discount at maturity, presumably 20-plus years after the swap. You state: “Best of all, the investor’s new bonds regained all of their lost market value in the following years,” but you don’t mention this tax liability. Admittedly, if the investor reinvested the $15,000 tax savings, and his tax rate were less than the maximum 35%, he might still come out ahead, but it pretty much seems a wash. Am I missing something?
H.B.
Great information on your site, especially the laddering truths, which most people don’t understand. I have a few questions: 1) Capital losses, for example: Buying zeros (at a bit of a premium over accreted value) and a short time later they are called at accreted value. Is there a capital loss to report on one’s 1040 schedule D? If yes, do you accrete them up to expected value based on your purchase price, then subtract for the loss? 2) Zero munis accrete, as we know. Does one report the accretion on the 1040 with other exempt interest? If yes, does one figure the accretion from one’s purchase price to maturity (not the bond’s original accretion)? If the bond was bought at a discount or premium to accreted value at the time of purchase, one would create a new schedule on a spreadsheet. 3) Similar to the first question above: Do zeros, if sold before maturity, ever create a cap gain or loss? If yes, is it based on one’s own accretion table (as in question two above)?
R.H., Kansas
Does this mean we would have to pay state income tax on income from municipal bonds that we own from out of state? We live in Florida.
E.S., Florida
If the Supreme Court rules in favor of the investors, and a state then decides to tax all bonds including its own in-state issued bonds purchased by residents of that same state, how will that effect tax-free interest currently being received from that state’s previously purchased tax-free bonds? Will that state’s previously purchased tax-free bonds then be subject to tax by that state? Will currently tax-free interest then be taxed? Or would the tax go into effect only on bonds/interest purchased after a decision to tax them is announced?
S.G.
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