Corporate Bond Rates vs Municipal Bond Rates
There are many differences when comparing corporate bond rates and municipal bond rates, and each type of bond may be ideal for some investors but not for others. Corporate bonds are issued by a company while municipal bonds are issued by a city, state, federal government, or other municipal authority. Both types of bonds are used to raise revenue, with corporate bonds helping the company and municipal bonds benefiting the municipal entity, but the rates for bonds issued by corporations may have significantly higher rates than municipal options. This is due to the fact that many corporate bond offerings are considered a higher risk, so the interest rate offered must be higher to compensate for the increased risk level. Municipal entities like the US Government are considered a low risk investment so the rates offered are typically much lower than corporate bonds.
When you are evaluating corporate bond rates you will need to take your tax situation into account, because these bonds have yields that are usually taxable. Municipal bonds may be exempt from city, state, or federal taxes, and for some investors this advantage may make a lower rate more acceptable. Some bonds called zero coupon bonds do not make periodic interest payments, and these are available as both corporate and municipal types. Some investors consider that the best corporate bonds are zero coupon bonds because these bonds are purchased at a discount and do not involve periodic interest payments. This means that taxes are paid when the bond is redeemed at face value instead of more frequently.
The relationship between corporate bond rates and corporate bond prices is one that is inverse, and this is also true with municipal bond rates and prices. When interest rates fall then bond prices will normally rise, and when interest rates rise then bond prices generally fall. This relationship is important for investors who choose to redeem bonds before the maturity date. Floating rate bonds have a rate that varies and is adjusted for any changes in interest on a periodic basis. If you ladder your bond maturity dates, whether you choose corporate bonds or munis, this will help prevent any drastic rate drops over the long term regardless of other relevant factors.
When you compare corporate bond rates and municipal bond rates this will not determine the actual yield of each investment type. You will also need to calculate the tax equivalent yield for municipal bonds to determine which type of bond offers a better rate overall. Your income and current tax bracket will play a role. When you invest in the corporate bond market the yield is generally taxable, while municipal bonds are not typically taxed. Unless you calculate the tax equivalent yield for the municipal options you are comparing apples and oranges. Individuals in a higher tax bracket look for tax exemptions when investing in municipal bonds, while investors who are not in the top tax brackets find the tax exemptions less valuable.