The Bond Market: Municipal Bond Pricing

If you’re not too familiar with the municipal bond market, there are a few things you first have to know. A municipal bond is a type of bond issued by a local or state government to raise money for major capital projects. The purpose of these types of bonds is to generate money to build hospitals, schools, bridges, roads, sewer systems, prisons and much more. Local governments pay interest on a municipal bond to the bondholder, usually every 6 months. An attractive feature of many municipal securities is that the interest you receive is usually exempt from federal income tax. Interest may also be exempt from state and local taxes, depending on the state where the muni bonds are issued. For in depth information about municipal bonds, including tax information, safety and pricing, visit The Securities Industry and Financial Markets Association.

Bond Pricing

Investors should fully understand the concepts of bond pricing before investing. Bond pricing and yield are the only two elements in a bond that fluctuate based on market conditions. Yield is the percentage return that investors will receive based upon bond maturity completion, interest rate and price. The best way to understand bond pricing is to think of it as cents on the dollar. Every bond is quoted as cents on the dollar. 100 is par or 100 cents on the dollar. If you are given a price of 100 on 10K that would mean that $10,000 worth of bonds would cost you $10,000. A price of 103 would mean that $10,000 worth of bonds would cost you $10,300. The fluctuating interest rate (coupon) of bond pricing often determines what type of municipal bond investments become attractive. If an investor is locked in at a formerly purchased 5% 10-year bond maturity rate, but the current interest rate is 7%, the investor might choose to sell his bonds at lower than face value. The only way to get rid of an older bond in this situation with a 5% interest rate is to sell it cheap. With the money the investor receives from selling his bond at a reduced price, he may now purchase a new municipal bond with a higher interest rate. A higher interest rate will over time generate more money.

In the bond market, the more information you know about bond pricing and interest rates, the more success you’ll have in choosing the type of bond that will most benefit your situation. Conducting research and bond analysis and keeping up to date on current interest rates are vital to every investor’s wallet.