High Yield Municipal Bonds

High Yield Municipal Bonds usually have a lower credit-rating than their investment grade counterparts or are not rated at all. These bonds pay higher relative interest to attract investors. High-Yield Municipal Bonds may offer the potential for higher income and total returns than investment-grade. Due to higher credit risk, these bonds may have greater volatility than bonds with higher credit ratings. Higher-risk, higher-return bonds can increase overall returns of an investment portfolio. Risk can be mitigated by diversification with investment-grade bonds and stocks.

Comparison between corporate bonds and municipal bonds

Comparing the coupon rates of municipal bonds to corporate and other taxable bonds must be done on an “after-tax” basis. Although yields on taxable instruments are usually higher than yields of municipal bonds, income taxes must be paid on the interest payments of the taxable securities. Tax-exempt municipal bonds usually have higher after-tax yields than corporate bonds with the same coupon rate because municipal bond interest payments are usually exempt from Federal, State, and Local income taxation.

After-tax Comparison

For example, an investor in the 35% tax bracket is considering a 6% Muni bond at par ($1,000 face value). To determine the “taxable equivalent” yield, divide the Municipal Stated Rate [MSR] by ‘100 minus Income Tax Bracket [ITB]’ or MSR / [100 — ITB].

A typical 6% Muni bond for an investor in the 35% tax bracket would look as follows:

6% / [100 — 35] = 6% / 65 = 9.23%. Because the yield on Muni’s is exempt from federal income tax, the 6% Muni yield offers the Taxable Equivalent Yield (TEY) of 9.23% of taxable bonds. The Taxable Equivalent Yield is higher if State and Local taxes are considered in the calculation.

• All Municipal Bond Offerings