Notes on the Current State of the Muni Bond Market

by Annette Thau

Notes On The Current State Of The Muni Bond Market Splash image

Are you worried about your bonds (or your bond funds)?

The fixed-income markets are currently getting very bad press. No less an oracle than Warren Buffett recently dubbed bonds “instruments of mass destruction.” The perception that risk is high is primarily due to the fact that interest rates remain at historic lows. The consensus seems to be that interest rates can only go up and this creates interest rate risk: When interest rates rise, the price of a bond (or a bond fund) declines. The extent of the decline is directly related to maturity length. The other face of interest rate risk, of course, is that when interest rates decline, the price of bonds rises. Again, the extent of the increase is tied directly to maturity length.

Interest rate risk affects all fixed-income securities, including Treasuries. Discussions of interest rates and interest rate risk all start with Treasury bonds. More precisely, these discussions focus on the bellwether 10-year Treasury bond, since interest rates in other sectors of the bond market typically follow Treasury rates, either up or down. If interest rates rise on Treasuries, so will those of municipal and corporate bonds.

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James from Illinois posted about 1 year ago:


I wonder if you are underestimating the political risk of municipal bonds. For example, what happens when the market is no longer willing to buy the debt of either Illinos or California? Do you think the politicians will choose to continue to service existing debt at the expense of state pensions and retiree health care benefits, or will they stiff "rich" bond holders seeking tax exempt income in favor continuing pension and health care benfits to hard-working Americans?



William from Florida posted about 1 year ago:

A couple of comments about the box on closed end bond funds. Another reason for holding this type of security is unrestrained liquidity. Many open ended bond funds (eg Vanguard) have frequent trading and liquidation limits that may effect one's ability to liquidate positions in down markets. Looking and the bond fund duration data will give a index of interest rate volatility. Finally many closed end funds sell at either a discount or premium for long periods. Buying a fund at a discount to NAV does not necessarily mean that it is a bargain. Looking at pricing history is a better way to figure this out.

John from California posted about 1 year ago:

First, interest rates are at historical lows manipulated by the FEDs. This is not the time to buy bonds. Second the muni market has not changed in 50 years; the spread in 3 percent. Dont try to sell a bond, you may get a low ball bid from an un-named source who is actually your own broker. Ratings are meaningless and can change overnight by several ranks. Insurance, regulated by the NY Insurance commissioner is a fraud. Small bond buyers over the last decade have been screwed by the banks, brokers and insurance companies. Speciffically, we were sold INSURED securities in a market unregulated to control insurance company default and fraud. Yet Wall Street continues to rake in the big bucks and sidesteps regulation attempts.

Will from Massachusetts posted about 1 year ago:

Given the assumptions listed, how long would interest payments have to be reinvested in a muni bond fund for the investor to get back to par after a 1% riase in intrest rates?

Assumptions: Duration of 7 years, an expense rations of .25% and a return of 3.8% of tax-exempt income

Don from Florida posted about 1 year ago:

Excellent article; thank you.

Patricia from New York posted about 1 year ago:

Being a holder of a municipal bond fund, I feel comfortable after
reading your article

Alan from New Jersey posted about 1 year ago:

This is an excellent example of clear financial writing. Thoughtful and measured, it is valuable for long time muni investors while being accessible to newcomers. Thank you Ms. Thau and AAII.

Douglas from Arizona posted about 1 year ago:

In evaluating closed end funds its also important to make sure that the fund is earning at least as much as it is distributing and that there are unused revenues (UNII) for problem periods. has all the info you need to select muni cefs that are paying upwards of 5% tax free.

anonymous from Illinois posted about 1 year ago:

Great article.

Pete from New Jersey posted about 1 year ago:

Enjoyed the article and thanks.... Any reason why I would need to diversify my individual bonds among more than one bond shop? I am presently using Stoever Glass in NYC. As you know, they recommend and buy the bonds for me and also hold the bonds. It is a little scary not actually having a bond as proof of purchase but I am told that that is the way it is done today. I do get confirmation statements and monthly statements.

Sound kosher to you ?

Thanks again.

Asghar from Connecticut posted about 1 year ago:

this article is the most informative presentation of bond, bond funds and munis i have ever read.exellent and honest descriptions of bond market.thank you.

Larry from California posted about 1 year ago:

"Yield to Worst" is not as comforting as it sounds. It does not, according to my experience, take into account sinking fund redemptions scheduled prior to maturity. Such sinking fund redemptions apparently are not considered "calls" as selecting non-callable only securities does not eliminate bonds with sinking fund redemption schedules and likewise such are not considered a 'call' when yield to worst is posted.

Daljit from Maryland posted about 1 year ago:

Very well explained a must read for all investors.

Joseph Turney from Kansas posted about 1 year ago:

I did not see any referance to the fact that any premium paid for tax exempt is not considered a loss for tax purposes.

S Frank from Connecticut posted about 1 year ago:

When are the muni bond professionals and bond buyers going to realize that yield to maturity, yield to call or yield to worst do not accurately reflect the yield on a muni bond? For example, if someone buys a bond maturing in 2030, with a 5% coupon and a YTM of 4%, they are not rally earning 4%/year. The YTM, YTC, YTW calculations assumes that the 5% coupon is invested at 4%, which is not likely. I have developed a more accuarte fomula for determing the yield on a bond. While munis still offer a good investment it's a real eye opener to calculate the "true" yields.

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