Market Analysis Considerations for Municipal Securities

Instructor: Yusuf Abdullah

Yusuf has taught Science and Mathematics at school level and Finance and Economics at University level. He has recently earned his Ph.D in Financial Econometrics field.

The lesson deals with the pre-issuance market considerations for municipal bonds. Learn about the factors that affect bond issuance and bond indices based on different bond types.

Market Analysis

Tony has been allowed to issue municipal bonds on behalf of his city. While Tony is happy to get financing benefits, he wants to be sure that investors' money is not threatened in any way. He has approached Michael to help him with market analysis for these securities.

Tony wants to gauge the market for the issue of bonds so that the bonds are sold easily. This would require assessing the demand of the bonds, the state of the economy, the savings with the investors, bond yields, and a number of other factors. Tony has already arranged for macroeconomic study and wants to know about the yield that should be offered for the bonds. Michael advises him to use bond indices as benchmarks and adjust the risk factors of his bonds likewise. After hearing this, Tony asks Michael to advise him about bond indices and how to choose them.

Bond Indices

Michael defines bond indices as the value-weighted yields or prices of the bonds constituting or included in the index. A number of indices can be constituted, but the most frequently used will be described in this section. Tony wants to confirm that the bond yield and prices are inversely related, to which Michael agrees.

Price Indices

Price indices are reported on the basis of price. The adjustment is made for par value by using either $100 or $1000 as par.

The 40 bond index is a value-weighted daily price index of 40 general obligations and revenue bonds. These bonds are currently actively traded and the index has been in existence since 1985.

Yield Indices

Tony remarks that yield index would report yield on the bonds rather than price. Michael agrees and adds that the yield reported is the theoretical yield as per the price index. This is also called implied yield. These indices are the average of the yields of the bonds.

Bond Buyer 20

Bond buyer 20 is the average yield of 20 general obligation municipal bonds. The average rating of the bonds in this index is Aa2 (Moody's) or AA (Standard & Poor's). This index is widely used to determine the coupons on new municipal bonds. The yield is determined by a survey of municipal bond traders, who are asked to determine the coupon for the new bond issue if they were sold at par. This helps the state or local government to help determine coupons for their bond. Tony is relieved that he would have a good benchmark to estimate coupons on the bonds.

Bond Buyer 11

Bond buyer 11 consists of 11 bonds from the bond buyer 20 index. Again, these are general obligation bonds since the index comes from the bond buyer 20 index. One of the defining characteristics of this index is that the maturity of the bonds is 20 years. It is the index of average yield, and the average rating of the bonds in this index is Aa1 (Moody's) or AA+ (Standard & Poor's).

Revenue Bond Index

Revenue bond index is the average yield of the 25 different municipal bonds with a maturity of 30 years. The average rating of the bonds in this index is A1 (Moody's) or A+ (Standard & Poor's).

One Year Note Index

The one year note index uses yields of 10 states and cities that issue cash-flow notes.

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