Investing Tax Free

Municipal Bond Yields

Municipal bond yields are a little more complicated to calculate than corporate bond yields. Because of the tax benefits of municipal bonds, municipal bond yields will always be less than the equivalent corporate bond yields. To really know if a municipal bond is a better investment than a corporate bond, you need to calculate the tax equivalent yield of the municipal bond. Below are municipal bond yields explained.

What are Municipal Bond Yields?

Municipal bond yields expresses the cash interest payments in relation to the municipal bond value. Municipal bond yields are determined by the issuer's credit quality, interest rates, time to maturity as well as any call features.

When there is a question whether the municipal issuer will have the ability to pay principal or interests, their municipal bonds often carry low ratings but will offer higher municipal bond yields.


Municipal bond yields vs Municipal bond ratings

There is a strong relationship between the municipal bond yields and the municipal bond ratings. In general, the higher the municipal bond rating, the lower the municipal bond yield. This is because of the tradeoff of having safety in the municipal bond. There is no such thing as a safe investment with high returns so investors have to choose either to put up with low ratings, high risks in exchange for possible high yields or to have a peace of mind and invest in a low yield municipal bond with high rating.


Different types of bond yields

Bond yields are used to compare tax exempt municipal bonds returns against each other, against other types of bonds or against other investments. Bond yields are useful because, apart from at the initial bond offerings, bonds trade at different prices, not just at par or face value. The ability to buy a bond at par, premium prices or discount prices make it hard to see at first glance how good an investment a particular bond is. The different yield calculations will help you determine which is the best bond to invest in.

The nominal yield is the bond's yield set at the time of issue. This is a fixed percentage of the bond's par value. A common yield of a bond is its current yield which measures the bond's coupon payment relative to its market price. Then there is the yield to maturity which represents the annualized return of the bond if it were to be held to maturity. Lastly, a useful yield is yield to call which is calculated on bonds with call features. Another useful tool to help you understand bonds and bond yields is the yield curve.