grok87 wrote:I'll be interested to see how the two different coupons price. According to the logic i laid out, the higher coupon bond should price so as to give a slightly lower yield to maturity. The reason that you are seeing the same YTM right now is that the bonds haven't priced yet so they don't really know how the market will value the different coupons.
From recent pricing results
on one issue, near-term (<= 2023) bonds were priced to the exact YTM regardless of coupon; longer term bonds had substantial higher YTM when coupon is lower. The issue in question is very small. Maybe it's not typical.
The data from that offering is actually quite interesting IMHO. I'll discuss the two maturities you mentioned and advance some hypotheses, in the form of a hypothetical discussion between the issuer, the bond underwiter, institutional investors and (clueless) retail investors. Note I am not meaning to disparage retail investors generally but IMHO retail investors should generally avoid buying individual muni bonds. It is actually a very complex area with opaque pricing and it is quite likely they will be taken advantage of. Stick to vanguard muni funds.
First the data:
Amount $150 k coupon 4% yield-to-maturity 2.47%
Amount $1.9 M coupon 5% yield-to-maturity 2.47%
Amount $180 k coupon 3.5% yield-to-maturity 3.6%
Amount $2.28 m coupon 5% yield-to-maturity 3.25%
Here's the hypothetical dialogue:
Issuer: I really need to issue some bonds here, but I hate paying high coupons. Ideally I'd love to issue zero coupon bonds- that would really help my cash flow.
Bond underwriter: I hate to tell you this but muni investors mostly want high coupon bond these days. Rates are low, but investors are afraid that if they buy at par with low coupons and then rates go up later, those par muni bonds will then trade at a discount. Then they'll have a hard time re-selling them before maturity if they want to, because those secondary purchasers will have to pay income tax on the amount of the discount. Nobody buys municipal bonds where they have to pay income tax on them-it's completely toxic.
Issuer: Hmm, I see what you mean. Well let's take this one step at a time. I want to sell some 10 year bonds. Yields are around 2.5% right, so what kind of coupon are we looking at here?
Bond underwriter: well let me ask my friend Mr. Institutional Investor A.
Institutional Investor A: I need a 5% coupon and a yield to maturity of 2.47%.
Issuer: 5% coupon!!! Yikes, that is painful. Mr. Bond Underwriter, help!!
Bond underwriter: Hmm. Well I think you are stuck with the 5% coupon for most of the bonds of this maturity. Institutional investor A is kind of calling the shots here as he is taking around 90% of the bonds or $1.9 M. But I may be able to round up some retail investors to take a slightly lower coupon of say 4% for the same 2.47% yield to maturity.
Issuer: But aren't they going to demand a bit higher yield-to-maturity for the greater price risk of the lower 4% coupon?- i.e. since the bonds have a lower 4% coupon, if rates go up in the future they are more likely than the 5% coupon bonds to trade at a discount and hit that tax issue you mentioned.
Bond underwriter: Well in theory yes, but those retail guys don't really know what's going on. Here watch this:
Bond underwriter: Hey Mr. Retail investor, I have this great deal for you. There is this bond offering where institutional investors have basically taken all the bonds. We're talking millions of dollars, here, the big table. But as a special deal for you, I can get you exactly the same yield to maturity of 2.47% as the big guys and you and your 14 friends only have to buy like $10k each. So you are getting "pretty much" the same deal as the big guys here. What a deal huh!
Retail investor: "Pretty much" huh! but wait my coupon is 4% but Mr. Institutional investors coupon is 5%. Does that matter?
Bond underwriter: Not really, no. The yield to maturity is what matters. There might be a difference in how the 4 and 5 coupon bonds' prices behave down the road if rates go up a lot. But no one's worried about that right? Live in the now!!!
Retail investor: where do I sign!?!
Issuer: Boy I'm glad that's over. I always feel a little guilty taking advantage of the retail investors in my state. They are the one's who elected me right? I'm sure glad I have you, Mr. Bond underwriter to do my dirty work for me so I can keep my hands clean. Then if I get asked why institutional investors got a better deal than retail investors I can just wave my hands and blame it on the mysteries of the bond market. Can you imagine if the stock market worked this way!
Bond Underwriter: No problem. Now let's get moving on that 2027 maturity. I've got some bad news for you on this one. Retail investors aren't really interested this time, it's kind of too long for them. So Institutional Investor A wants the same 5% coupon but a yield to maturity of 3.25%.
Issuer: Yikes, is there nothing can be done!!!
Bond Underwriter: Well I do have this one friend Institutional Investor B. He's a little different- an "honest to pete" buy and hold investor. Can you believe it, I thought they were extinct!!!
Issuer: ok, so what is he willing to do?
Bond underwriter: well since he is planning to hold to maturity he doesn't care about the interim price risk from that tax issue. So he'll take a coupon as low as 3.5% as long as he gets a yield of 3.6%.
Issuer: 3.6% yield to maturity! Yikes. I like the lower coupon because it back loads my bond payments. Heck I may not even be here in 14 years. But can I really justify paying this guy a 3.6% yield when the other guys are getting 3.25%? Also since both of these bonds are callable in 2023, institutional investor B is getting an especially sweet deal since his bonds are less likely to be called in 10 years. Say that in 10 years, 4 year bonds are yielding 4%. Then I'm going to want to call the 5% coupon bonds but I'll leave the 3.5% coupon bonds alone. How can I justify giving this guy such a sweet deal-Don't I have a fiduciary duty to get the best deal for my taxpayers?
Bond underwriter: Taxpayers/smaxpayers. You said you wanted a low coupon so you could backload your bond payments right?
Issuer: Yes, Yes I did. And again if anyone asks I guess I can blame all this on the mysteries of the bond market.
| "You can only convince people who think they can benefit from being convinced."- Taleb