### Muni Bond Question

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This may be a really stupid question, but I am having some difficulty finding out how to calculate if it would be more beneficial to buy in-state vs out-of -state munis for a client (35% fed tax bracket, 6.25% marginal state tax rate).  Everyone says buy in-state for the additional tax break, but is there not a point where the out-of-state bond yields more after the client pays the state tax?  What number should I be more concerned with in that situation, coupon or YTM?

Maybe I am thinking too much but if two bonds are identical in maturity, coupon, etc., and the YTM is higher on the out-of-state bond, is there a point where the out-of-state bond is a better choice?

Thanks

Assuming that the bonds are both of equal credit quality, maturity, coupon etc. The client should buy the bond in his/her own State to take the double tax break.

If the coupon only is different its a simple math problem to figure out which would give the better yield.  If the YTM on similar coupon bonds with similar maturities is different there is something else going on that you should be looking at.  Credit quality.  Call features.  Sinking fund. General Obligiation bond.  AMT qualified or not.???

I don't worry about YTM unless I'm buying a bond at premium or discount.  Also consider yield to call. That actually may be the more important number.

At 6.25 probably not, if you were in a lower tax state maybe. If you are in a no tax state then yes, if it has a higher yield.

Theoretically, bond from a state that does not have a state income tax should trade cheaper than one from a state with one.

Look on your bond inventory and see if the Florida bonds are trading with a higher return than your state's.

Then (if it is) just do the math. 5% (in state) divided by .5875 gives you a taxable equivalent yield  of 8.5 ish (approximately because you get to take your statae tax off the federal so the overall number drops by a percent or three, you probably have a muni calculator somewhere in your office or on your machine.) then take the 5.5% Fl bond and  divide  by .65 and your TEY is 8.4 ish, in state wins.

Do it a few times and figure out if the rule of thumb is that the out of state bond needs to beat the instate (plus Puerto Rico, Guam the Virgin Islands and Washington DC*) bonds by more than 10% then it's as good or better to go out (assuming all other variables are matched up).

* Don't quote me on DC I've seen it said both ways and I hold them on a GTA basis only.

OK, the better yield to pocket question is a simple math exercise. However, the all things being equal with two bonds is unlikely. The good thing about muni's is all the warts they come with. The bad thing about muni's is all the warts they come with. And those warts make all the difference. On the plus side, a wart that isn't an issue with a client may enhance the yield. On the negative side, a wart that makes all the difference to a client may be a deal killer.

On the YTM question, most muni buyers are buying for income, not for asset diversification. Not all, just most. For this reason the coupon and current yield are the more important numbers. More important than YTM. Clients may want to increase their income by buying premium bonds. And by the way, because premiums are considered a wart these bonds are usually well priced if not underpriced.

As for investment grade discount bonds, the discount will be forgotten by the client as soon as they receive their first undermarket coupon. Not a happy conversation.