Municipal Bond Forum
Premium paid on muni bonds is a return on principal
Q
I have a question about municipal bonds selling at a premium: If I buy, for example, a 10-year face-value muni bond with a 5% coupon for $1,000 par and pay a 10% premium over par, I pay $1,100 to buy the bond. When the bond matures, I get back $1,000 and earn the stated yield-to-maturity when I purchased the bond. Assume that I can roll over a maturing $1,000 bond and use the proceeds to obtain a new bond selling at $1,100. To obtain the $100 premium, assume I go into my checking account.
Isn’t the upfront $100 premium simply returned to me over the life of the bond in the form of a slice of each coupon interest payment? That is, isn’t repayment of the $100 premium simply a return of my investment ($100), not a return on my investment ($100)?
A
James A. Klotz responds:
Bonds trade above par (100.00) if they possess a coupon rate higher than those of bonds currently being issued.
Although premium bonds mature at face value, the premium paid is not a return of principal, it is a return on principal. This is evidenced by the yield calculations (yield-to-call and yield-to-maturity).
The premium paid is factored into both calculations, and all investment dollars are working at these stated yields, including the premium dollars.
We write a lot about premium bonds. Read, for example, “Hidden Gems in the Muni Market.” It goes back several years, but the points are as valid today as they were then.
Start here.
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