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There are two very important types of bond yields; current yield and yield to maturity. Current yield is the annual return on the dollar amount you paid for the bond. Yield to maturity is the rate of return you receive by holding a bond until it matures. The yield to maturity calculation takes into consideration current price, par value, interest rate and time to maturity. It also assumes interest payments are reinvested at the current yield the investor is receiving on their investment.
The return on a bond investment is usually stated in terms of yield to maturity. For example, if you purchase a bond with a 6.0% coupon rate at par, its yield to maturity is 6.0%. If you pay more than par, the yield to maturity will be lower than the coupon rate and yield to call must be considered.
When the price of a tax-exempt municipal bond increases above its par value, it is said to be selling at a premium. When the security sells below par value, it is said to be selling at a discount.
If you sell a municipal bond for more than your original purchase price, you may generate a capital gain. Long-term capital gains require a 12-month holding period, while short term gains result from a sale of bonds held less than 12 months.
If you sell your security for less than your original purchase price, you may incur a capital loss. Under current law, up to $3,000 of net capital losses can be used annually to reduce ordinary income or the entire loss can be used to offset capital gains.
A municipal bond purchased at a premium or a discount and called or sold before maturity may have tax consequences. Since tax laws frequently change, it is wise to consult with your tax lawyer or accountant for up-to-date information and advice.
Many bond indentures allow the issuer to call – or retire – all or a portion of the bonds at a premium, or at par, before maturity. When buying municipal bonds, be sure that you ask your investment advisor about call provisions and the difference between the yield to call and the yield to maturity.
Put a municipal bond specialist to work for you. Here at THE GMS GROUP, municipal bonds are our core product and we possess the knowledge, resources and expertise to help you make the best fixed income investment for your financial needs and goals. Contact us today for more information or simply call 877-467-0070.