Municipal Bond Forum
Premium paid on muni bonds is a return on principal
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)?
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.
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