Forget about Municipal Bond Rates

By Avery Putnam

Municipal bond rates are not important when deciding what municipal bonds to invest in. However, most people, especially new municipal bond investors look at the municipal bond rates before anything else and invest in the bonds with the highest rates. While sometimes municipal bonds with highest interest rates are the best investments, it is not always the case. After all municipal bond rates do not take into account the prices of the bonds and the maturity dates.

Municipal bond rates or municipal bond interest rates are also called coupon rates. Coupon rates are published in financial papers next to the name of the municipal bonds. Municipal bond rates do not change over the life of the bond and they are set at the time of the issue based on the needs of the issuer. When the market condition changes, the municipal bond rates still do not change.

Municipal bond rates do not always change to reflect the risk associated with the bonds. Different bonds have different characteristics such as maturity dates, interest rates as well as prices. It is common sense to assume that municipal bonds with higher risks should have higher interest rates but this is no always the case. There are plenty of municipal bonds that have different characteristics such as longer maturity dates and higher prices that have the same interest rates.

While the municipal bond rates may stay the same for all maturity dates, the yield of the municipal bond should be different. This is why advanced municipal bond investors look at municipal bond yield more than their interest rates. The yield calculation takes into account factors such as the maturity date and price, unlike the coupon rates.

There is not just one type of yield to calculate, there are a few. While municipal bond rates are published and states without dispute, municipal bond yields can be calculated in different ways. However in all yield calculations, the municipal bond rates are used but they are then lowered by the prices that investors have to pay for the bonds as well as the time they have to wait to be repaid.

The price of a municipal bond can make the bond less attractive even when the interest rate is high. Municipal bonds can be bought at par, at premium or at a discount price. If an investor is paying more for the bond, buying it at premium, the investor should be compensated with high enough interest rates so that in the end the investor comes out ahead. For example, a $100 investment that pays you $1 for 10 days and also $100 at the end is better than a $30 investment that pays you $1 for 10 days and only $10 in at the end. For an investor to invest $30, the bond needs to pay more than $1 a day or pay for longer than 10 days. This shows that considering municipal bond rates alone is not adequate.

Also, the longer the time to maturity, the higher the municipal bond rates should be. For example, consider the following investments. For a $10 investment you will get your money back plus $1 a day for the 5 years or for the same investment you will get $1 a day for the next 10 days. In the latter case, you know you will get your money back soon plus $10 more whereas in 5 years time things could have changed tremendously. There may be other better investments such as $2 a day interest which you cannot participate in because you already lock in your money.

In conclusion, higher municipal bond rates do not always mean better investments. It is better to consider the bond yield rather than its coupon or interest rates. This is especially true when an investor is investing long term. Higher yield is needed to compensate the investor for taking on more risk.

Municipal bonds have almost always been the favorite way of investing for the very richest people on the planet for over half a century. If you'd like to learn more about Municipal Bond Rates, drop by Investing Tax Free today.

Seek and Learn Free printable crosswords Free printable sudokus

Copyright 2008 Mirroreyes Internet Services Corporation.