How to Measure Municipal Bond Performance
There are standard techniques for reviewing the performance of municipal bonds that investors should consider when purchasing or deciding to sell their holdings. Because municipal bonds do not issue annual reports it is important for the investor to gauge the health of their holdings. Municipal bond performance should be gauged by its bond rating stability, its performance with regards to other municipal bonds, and performance with respect to other fixed income securities.
Other People Are Reading
Instructions
-
Municipal Bond Performance Measures
-
1
Monitor credit rating changes. Municipal bonds are very secure debt instruments and rarely is it necessary to sell because of a change in the bond's credit rating. Credit downgrades lower bond values. Ensure that municipal bonds ratings affected by changes in taxation and spending policies within the state will maintain their credit rating. Investors should review, at least on an annual basis, the current rating and trends of any bonds they own. During times of financial stress and budget cutbacks funding sources and tax receipts may decline sufficiently that the existing credit rating will be reevaluated by the major bond rating services.
-
2
Consider the performance of a municipal bond against that of taxable bonds, particularly United States Treasury bonds of the same maturity. The 'spread' or difference in yield between the two fixed income securities gives an indication as to which bond is becoming more attractive to investors. Note that municipal bond yields occasionally exceed Treasury bond yields by one percent or more. Note that this is indicative of a long term buying opportunity for municipal bonds.
-
-
3
Estimate the approximate difference in spread between different maturity and differently rated municipal credits. When economic times are difficult credit quality tends to emphasize high grade credits. During strong economic times investors prefer more yield because nearly all credits have stronger financial strength. Choose an appropriate credit risk relationship during a business cycle and add several percent to the total performance of a municipal bond.
-
4
Compute the total return of a municipal bond. Choose a period of not less than one month. Compute all earned coupon income for the period under study. Subtract the market value of the bond at the start of the period from the end of the period. Add the income stream and the capital gains. The sum is the total return. Divide the total return by the beginning period price. The result is the percentage total return. Use the result to compare to other bonds or asset classes. For example, a bond costs par, or 100 and a year later is worth 105. Income received is 6. Total return is 11. Percentage total return is 11 divided by 100 or 11 percent.
-
5
Compute a risk and return chart. List a yield curve showing the yield of popular maturities of the same credit quality out to 30 years on a spreadsheet. Divide the yield of each year by the yield of the 30 year yield. For example, the 30 year yield is 5 percent. The five year yield is 3 percent and the 10 year yield is 4 percent. The percentage yield for 5 years is 3 divided by 60 percent. The 10 year is 80 percent. The result shows how much of the maximum yield can be captured by extending out the yield curve. Most maximum return can be captured with less than half the maturity risk.
-
1
Tips & Warnings
Do not use short periods of time when computing total return. Short time periods reflect only random moves.
References
Resources
- Photo Credit bond of the state loan, russia, 1951 year image by air from Fotolia.com
