Choosing Discount Rates for Municipal Bond Valuation
Summary
The document discusses selecting discount rates to estimate the fair value of a municipal bond when its market price is unknown. One response points to the MMD AAA general-obligation, non-callable zero curve as a standard reference curve and suggests checking for a comparable Bloomberg source. This provides a market-based starting point for discounting municipal cash flows.
A second response offers alternatives when a suitable curve is unavailable: discount at the investor's required yield or use the yield of bonds with similar maturity and credit risk, potentially applying that yield as a constant rate for a rough estimate. The choice depends on understanding default risk, which can vary with the issuer and repayment source. A constant yield is only an approximation, especially when market curves are steep or twisted; the document does not provide a bond-specific curve, cash-flow calculation, or tax adjustment.
Key ideas
- The MMD AAA GO non-callable zero curve is offered as a standard municipal benchmark.
- A comparable curve or similar bonds can inform discount rates when a direct market curve is unavailable.
- An investor's required yield can be used to estimate a personally acceptable price.
- A constant yield is a rough approximation when the market curve is nonlinear.
- Credit risk depends partly on the issuer and the source of repayment.
Tags
Full text
# What discount rates should I use to price a municipal bond with unknown market price? # What discount rates should I use to price a municipal bond with unknown market price? I have a payoff structure but I do not know the price of the bond. The bond is municipal. What discount rates should I take for each period in order to calculate its fair price? ## Answer by Kch (score 1) https://quant.stackexchange.com/a/41961 The standard curve for this is the MMD AAA GO NC Zero curve published by Thomson Reuters. There is likely a Bloomberg equivalent, you can check using AAA ## Answer by D Stanley (score 1) https://quant.stackexchange.com/a/81736 If you want to price a bond and don't have a good yield curve for discounting, there are a couple of other ways that you can come up with a price that is "fair" to you: - What rate of return (yield) would you require to buy the bond? That would tell you if the bond cost more or less than you would want to pay. - What is the yield of other similar (in terms of maturity and credit risk) bonds? It's fine to use that as a constant discount rate to get a reasonable price. Using an appropriate discount factor means that you have a good understanding of the risk of default, which may or not be a simple question depending on the issuer and the source of repayment funds (e.g. is it project-based or just based on the credit of the issuer). There will be some idiosyncrasies in some cases, e.g. if the market yield curves are significantly non-linear (steep or twisted), but if you just want a rough indication of a fair price than a constant yield can give you that.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.