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How do I calculate my expected return if I buy a municipal bond at a premium with a sinking fund feature?

For example, I'm looking at a bond with a coupon of 5.5%, maturing July 2015, with the following sinking fund schedule:

 Date       Price   Amount
 07/01/2013 100.000 $1,155,000
 07/01/2014 100.000 $1,220,000 
 07/01/2015 100.000 $830,000

There are no other call provisions.

The bond is currently priced at $103. My broker states the yield to maturity as 3.8%. I don't think this yield figure is correct. If I understand the redemption process correctly, more than a third of the bonds I would buy now (in May 2013) would be called at par in less than 60 days, resulting in a capital loss of $30 per bond.

How do I correctly calculate the yield to maturity?

  • 1
    Is the sinking fund simply a provision where they are setting funds aside or is it a true call provision? – JTP - Apologise to Monica May 6 '13 at 17:02
  • Can't tell for sure, but since the schedule lists a price (par) and the bonds are listed as lacking "sinking fund protection," I'm presuming the issuer is paying off the debt by calling a portion of the bonds each year. – Tony the Pony May 6 '13 at 18:16
  • 2
    Important to know whether there's a call provision. A sinking fund does not always mean callable. You have the CUSIP handy? – JTP - Apologise to Monica May 6 '13 at 18:46
  • 2
    CUSIP: 226688BB4 – Tony the Pony May 7 '13 at 6:39
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You should refer to the following link to better answer your question.

http://trades.municipalbonds.com/bonds/issue/226688BB4

If you look at the Date of May 6th, the OP pasting date, you can lok at the chart and see what the YTM was near the quoted price of 103. It was slightly higher than his broker quoted him, coming in at 3.934.

As for calculating the YTM yourself you have several options;

  1. Use "Yield" in excel, this is my preference as you can make side by side comparisons of several muni's.

  2. Use an online calculator-I like http://www.moneychimp.com/articles/finworks/fmbondytm.htm look for the "pop-up" calculator. Be mindful that this is extremely simplified.

  3. Search the Cusip and rely on the issuers calculations.

  • Thanks, but my question concerns a different issue. I understand how to calculate yield to maturity, as long as the entire principal is paid back at the maturity date. What I'm unclear about is the effect of a sinking fund on expected yield. If I buy bonds today at a premium and they are redeemed at par far earlier than maturity, this capital loss eats up part of my return -- but how much? – Tony the Pony Jun 21 '13 at 13:13

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