What Do I Do Now?

Today’s installment is focused on practical application of the knowledge we’ve gone over thus far. You can reference this post when you’re looking at the three parameters of other munis, just in case you forget what everything means in context.

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III. What do I do now?
Enter you, the lay investor. You are a true rogue agent, a splinter cell - you owe allegiance to none but yourself. No silly contracts bind you. You look to your old friend, the ACY formula, for guidance:
ACY = [(Coupon ÷ Price) x Face Value] + [(Face Value - Price) ÷ YTM]
Like any true friend would tell you, he says:
1)    Buy at a low price,
2)    Go for a higher coupon (if possible), and
3)    Look for a short maturation period (small YTM)
To understand this advice, let’s flesh out an example. Thanks to Kevin Olsen’s work out of the site municipalbonds.com, anyone can see the highest and lowest yield trades for almost every day of the past 10 or so years. We will use the data from an exchange from the beginning of this year - the muni for the Sheppard Pratt hospital in Baltimore, MD. It can be found here (URL: http://municipalbonds.com/yields/yieldbuyers/20090102.html)
Look three rows down, and you’ll see it. Some very smart and quick individual bought this muni on the 2nd of January for 93 cents on the dollar (the actual value is 90, which is what we use for the calculation). The annual coupon is 5% (as usual), and the YTM is an astoundingly short 6 months. And the kicker? From all of that, this lucky person is getting a 21% yield on his investment in exactly half a year. Let’s plug in the values to see exactly how that happens.
[(Coupon ÷ Price) x Face Value] + [(Face Value - Price) ÷ YTM] = ACY
[(  0.05     /   90   ) x     100         ]  + [(    100      -    90 )     /   0.5]    =  21
Now, the calculation shown here is approximate - you won’t get the exact values shown on the site (this calculation actually gives you a 20.55% return yield instead of 20.93%), but you get the general idea. Look for a low price and a short maturation period, and you’re in the green. A high coupon is nice, but if it’s too high (something ridiculous like 80%) then you know something’s wrong. Use your common sense, and you’ll be fine.

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Part IV, the finale, comes tomorrow! Stay tuned.