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Forget about Municipal Bond Rates

Sep 10, 2008
Municipal bond rates are not important when deciding what municipal bonds to invest in. However, most people, especially new municipal bond investors look at the municipal bond rates before anything else and invest in the bonds with the highest rates. While sometimes municipal bonds with highest interest rates are the best investments, it is not always the case. After all municipal bond rates do not take into account the prices of the bonds and the maturity dates.

Municipal bond rates are coupon rates of the municipal bond. They are the rates that the issuer set at the time of the issue how much they will pay investors for the money borrowed. When a municipal bond issuer issues a bond, the issuer works with the underwriters to come up with the appropriate interest rates, the municipal bond rates, to satisfy the issuer's financial needs taking into account the market demand and supply. The municipal bond rates stay the same throughout the life of the bond.

Municipal bond rates do not always change to reflect the risk associated with the bonds. Different bonds have different characteristics such as maturity dates, interest rates as well as prices. It is common sense to assume that municipal bonds with higher risks should have higher interest rates but this is no always the case. There are plenty of municipal bonds that have different characteristics such as longer maturity dates and higher prices that have the same interest rates.

While the municipal bond rates may stay the same for all maturity dates, the yield of the municipal bond should be different. This is why advanced municipal bond investors look at municipal bond yield more than their interest rates. The yield calculation takes into account factors such as the maturity date and price, unlike the coupon rates.

There is not just one type of yield to calculate, there are a few. While municipal bond rates are published and states without dispute, municipal bond yields can be calculated in different ways. However in all yield calculations, the municipal bond rates are used but they are then lowered by the prices that investors have to pay for the bonds as well as the time they have to wait to be repaid.

Municipal bonds can be purchased at par, lower than par or higher than par. The price you pay for the municipal bonds highly influence how good of an investment the municipal bonds are. The municipal bond rates should play a minor role in deciding whether to invest in a municipal bond. For example, a $10 investment that pays you $1 for 5 days and also $10 at the end is obviously better than a $30 investment that pays you $1 for 5 days and only $10 in at the end.

When a bond has a longer life or longer time to maturity, the investor should be paid more. Municipal bond interest rates should increase when the time to maturity increases. This is because anything can happen during the time to maturity. The market interest rates could increase making an investor's municipal bond investment not worth while. The issuer could be in trouble or the project that the bond is based on could be halted. There are many reasons why investors need to be compensated more for longer life of the bond. However, this is not always the case.

Because so many things could change over time, the municipal bond rates alone cannot judge how good the bonds are. You need to look at other factors such as the yields, the price of the bond as well as the issuer. Even municipal bonds can be risky and not worth investing sometimes.
About the Author
Municipal bonds have almost always been a standard investment vehicle for the very richest people worldwide for generations. If you'd like to learn more about Municipal Bond Rates, drop by Investing Tax Free today.
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