Investing in the High Yield Municipal Market: How to Profit from the Current Municipal Credit Crisis and Earn Attractive Tax-Exempt Interest Income

Common Yield Measurements

There are several different ways to measure the yield on a municipal bond investment, or any bond, for that matter. One should always be clear about which yield metric is being used to transact, as each metric reflects very different assumptions about the potential return on your investment. In the fixed-income sector, the most common yield measurements are: (1) current yield; (2) yield-to-worst (YTW); and, less frequently, (3) yield-to-average-life. Instead of rehashing the mathematical yield formulas (for which numerous reference works are available), let’s focus instead on how you should interpret these yield calculations for everyday trading.

Current Yield

Current yield is computed by dividing the coupon rate by the dollar price of the bond. For instance, a 6.00 percent coupon bond purchased at a price of 98 ($980 per $1,000 of face value) will have a current yield of 6.12 percent (6.00/.98 = 6.12). Current yield is a rather crude measure that allows you to quickly gauge how much tax-exempt income you can buy per dollar invested. It is potentially misleading since it does not take into account the time value of your money or any other technical features of the bond that may affect the actual return (e.g., call or put provisions).

Yield-to-Worst

Yield-to-worst, as its name implies, is the most conservative yield measurement you can use. It tells you what you’re likely to earn in a worst-case scenario, taking into account all the technical features of ...