Vol 5 p371. “Because of the tax-exempt feature of municipal bonds, the yield on municipal bonds is less than that on Treasuries with the same maturity.” Does this always hold? Interest income from Treasuries is exempt from state/local taxes but not from federal tax. Interest income from tax exempt muni bonds maybe exempt from three levels of tax or maybe not. Muni bonds also bear greater credit risk and liquidity risk than the comparable Treasuries, how can these not factored in the yield?
hyang Wrote: ------------------------------------------------------- > Vol 5 p371. “Because of the tax-exempt feature of > municipal bonds, the yield on municipal bonds is > less than that on Treasuries with the same > maturity.” Does this always hold? > > Interest income from Treasuries is exempt from > state/local taxes but not from federal tax. > Interest income from tax exempt muni bonds maybe > exempt from three levels of tax or maybe not. Muni > bonds also bear greater credit risk and liquidity > risk than the comparable Treasuries, how can these > not factored in the yield? Yes. One way to see is use the tax free to after tax yield formula. AT Yield = Tax Free/1-tax rate
See http://www.bloomberg.com/markets/rates/index.html National Municipal Bond Yields: Triple-A rated, Tax-Exempt General Obligation Bonds 30-Year CURRENT YIELD: 4.81% U.S. Treasuries: 30-Year CURRENT YIELD: 4.47% **************************************************************** National Municipal Bond Yields: Triple-A rated, Tax-Exempt General Obligation Bonds 5-Year CURRENT YIELD: 3.02% U.S. Treasuries: 5-Year CURRENT YIELD: 3.1% **************************************************************** Thus the above data showed different results: For the 30 year maturity sector, muni bond has higher yield while for the 5 year maturity sector, Treasuries has higher yield. How do you comment the conclusion from our CFAI curriculum?
hyang Wrote: ------------------------------------------------------- > See > http://www.bloomberg.com/markets/rates/index.html > > National Municipal Bond Yields: > Triple-A rated, Tax-Exempt General Obligation > Bonds > 30-Year CURRENT YIELD: 4.81% > > U.S. Treasuries: 30-Year CURRENT YIELD: 4.47% > > ************************************************** > ************** > National Municipal Bond Yields: > Triple-A rated, Tax-Exempt General Obligation > Bonds > 5-Year CURRENT YIELD: 3.02% > > U.S. Treasuries: 5-Year CURRENT YIELD: 3.1% > > ************************************************** > ************** > > Thus the above data showed different results: > For the 30 year maturity sector, muni bond has > higher yield while for the 5 year maturity sector, > Treasuries has higher yield. > > How do you comment the conclusion from our CFAI > curriculum? Easy, don’t question the CFAI since they write the exam.
well the cfai book talks about the general case (normal market conditions) . Only 30 years munis have higher yield (11 bps in this case). I dont think 30 years treasuries is anything that we should look at in case of munis … bcoz treasuries issues no more 30 years bonds … so it has a limited supply, on the other hand there is plenty of supply in 30 years munis … excluding this special case … I think the CFAI material is correct. I dont have much experience in munis other than what I read in CFAI material and other general knowledge … may be someone else can explain better.
“bcoz treasuries issues no more 30 years bonds” Sure they do. There’s an auction this month for example. " “Because of the tax-exempt feature of municipal bonds, the yield on municipal bonds is less than that on Treasuries with the same maturity.” Does this always hold? Of course not. First, every muni has credit risk and even a AAA muni has credit risk now because everyone thinks the insurers might fail. Second, there are munis out there with serious hair on them including optionality and credit risk that have much higher ytm’s than Treasuries because you are taking on these risks. It used to be that there was a muni bond futures contract and you could trade the spread called the “MOB spread”. I think the muni bond contract is gone now or maybe it’s just slipped off my radar.
In CFAI book " Equity and Fixed Income" Volume 5, pg 299 4th para last line … “As of this writing, the US Department of Treasury has stopped issuing Treasury bonds” I think things have changed since the writing in the book … CFAI has to correct the sentence in the book
I checked the errata on CFA site and also the treasury auction calendar @ http://www.treas.gov/offices/domestic-finance/debt-management/auctions/auctions.pdf there was an auction of 30 yr bond on aug 7, 2008. The sentence that I pointed above is incorrect. It may have been correct at the time of writing … and I think its old now… thanks to Joey for pointing it out …
I think you guys are reading too much into the statement. Simply put, generally muni yields are going to be lower than treasuries or any other fixed income product because of the tax-exempt feature. someone put the after-tax yield formula further up… if the yields were the same, then it would be inefficient. if both yields were 4%, on the treasury you would be receiving lower than 4% due to taxes whereas on the muni you would be receiving the full 4%. Effective yield is different after taxes, hope this helps and hope i made sense. good luck guys on L1.