Premium Municipal Bonds: Myth vs. Fact

Imagine two bonds: one priced at $100 and the other at $105. Which would you choose? At first glance, most investors would pick the bond trading at par. But price alone tells you little about a bond’s future return. As it turns out, the supposedly more expensive choice—the premium bond—could return just as much, or more, depending on the market environment.

That’s not all. Contrary to some common myths and misperceptions, premium bonds have several advantages that may make them attractive candidates in a municipal bond portfolio.

Myth 1: Buying Premium Municipal Bonds Is Overpaying

It’s true that premium bonds cost more than par munis. But investors get something in return: higher coupons and higher interest payments. Thanks to this larger income stream, a premium bond could deliver the same return as a par bond (Display). This also clarifies another misconception that investors lose the premium upon maturity and incur a capital loss. On the contrary, the higher price adjusts lower over time as the coupon is paid until it ultimately pulls its way back to par at maturity. This means a premium bond priced at $105 won’t induce a $5 capital loss at maturity.

more income

In our example, given a hypothetical $1,000,000 investment, a premium muni bond’s face value is less than that of a par bond. However, the higher 5% coupon generates higher income over time—more than $280,000 versus $240,000 for the par bond, not including interest on coupon reinvestment. As a result, both bonds post the same return.