When buying a muni bond, the buyer becomes a “creditor” or lender to the municipality issuing the bond. Here are some important terms and definitions associated with municipal bonds.
Face value: Also called the par value, is the value of the bond. This is the amount that will be returned when the bond matures or is called. Municipal bonds usually trade in $5,000 increments.
Maturity date: The date when the bond “matures” and the face value is returned.
Callable bond: A callable bond may be “called” back by the issuing municipality at a date earlier than maturity. Basically this gives the issuer the opportunity to pay back the loan before it is due. (It is similar to paying of a mortgage early.) Dates at which the bond may be called are always listed.
Coupon rate: The coupon rate is the amount of interest paid, usually semi-annually (every 6 months). The yield is based upon the face, or par value, of the bond. For example if the face value of the bond is $10,000 and the coupon rate is 5% then every 6 months the bond holder receives a payment of $250. (10,000 x 0.05 = 500; 500/2=250).
General Obligation (GO) bond: GO bonds are bonds that are backed by the taxing power of the municipality issuing the bond. This simply means that the government (state or local) can and will initialize a tax to make the interest payments.
Revenue bond: Revenue bonds are backed by the ability of the project to generate revenue. Usually these types of bonds are issued for ball parks
Prerefunded bond: A prerefunded bond is exactly what it sounds like. The money to pay off all bond holders at maturity is set aside in an escrow account.
Current Yield: The annual dollar amount of interest versus the price that you paid for the bond. Using the bond above, if the bond was trading at a premium of 105, the price paid for the bond would be $10,500. The yield is 4.76% instead of the 5% coupon rate. (Current yield = 500/10,500) If the bond was trading at face (par) value 100, then the current yield is equal to the coupon rate of 5%
Yield to maturity: The amount of interest you will receive by holding the bond to maturity.
Yield to call: Call dates are prior maturity, it is a calculation of the interest received to the call date.
Taxable equivalent yield: Many municipal bonds are both federal and state tax exempt. The taxable equivalent yield is the amount you would need to get from a taxable bond, like a corporate bond, versus the tax-free yield of a muni bond.
Accrued interest: Bonds pay interest on a semi annual basis. The interest is paid to the individual holding the bond on the date. For example, suppose interest is paid on January 15 and July 15. If the bond is purchased on May 15, the total the purchaser pays includes interest from January 15 to May 15. The “accrued interest” is due to the seller. The bond purchaser will receive a full interest payment on July 15.