How to Calculate Municipal Bonds

Calculate and compare investments carefully

There are several bond calculations that are of use in determining investment value and comparing bond yields. All calculations can be done with simple downloadable programs from the Internet or by employing the net present value function from a spreadsheet calculator.

Instructions

1. Calculate bond yields with the use of a bond calculator. A suggested calculator may be found in the Resources section. Enter the coupon, maturity and call feature to calculate yield to maturity and yield to call.

2. Calculate and choose the higher-yielding (lower-priced) value between the call and maturity value. This is the yield and price at which the bond should trade. It would be illegal to use the higher-priced security.

3. Calculate current yield by dividing the coupon by the price of the bond. If the bond is at a discount from par, the yield will be higher than the current yield. A premium or price above par creates a higher current yield than the yield to maturity.

4. Calculate total return by adding the coupon and the change in price over the past year. Divide the sum by the price a year ago. Municipal bonds priced at 85 a year ago and worth 100 (or par) today with a 5 percent coupon have appreciated (15 + 5) or 20 points. The total return is 20/85 or 23.8 percent.

5. Compute the advantage of municipal bond yields with taxable yields by multiplying the taxable rate by (1 -- your tax rate). Presume the taxable bond is 8 percent and the municipal rate is 7 percent. If your tax rate is 25 percent, then the rate at which a municipal bond is equivalent to a taxable bond is 8 x (1 -- .25) or (8 x .75) or 6 percent. Choose the municipal bond and gain 1 percent or 12.5 percent more yield.

Tips & Warnings

• The most important yield is the maturity/call calculation. The current yield is simply a snapshot of that day's market value of the bond. It is not very useful for investment comparison.

• Take time to understand the uses for each calculation. Misusing yield to maturity for a bond already called would be a big blunder.

Resources

• Business News and Trading Links
• Bond Calculator With Accrued Interest Function