Yield shocks underestimate the interest rate risk of callable bonds

Bond Buyer

When thinking of interest rates in the taxable world, practitioners look at bellwether indicators such as the 10-year U.S. Treasury yield, and more broadly at the Treasury yield curve — a representation of the interest rates that investors demand across the maturity spectrum. The frequency of the U.S. Treasury’s issuance of bonds at or near par and the liquidity of that market make the Treasury yield curve an ideal benchmark.
When bonds are issued as callable in 10 years with above-market 5% coupons, as is the current practice with munis, equating yields and interest rates becomes questionable. Muni benchmark yield curves represent the yields-to-call of these bonds. Thinking of the yield-to-call of, say, the 5% 20-year benchmark bond as the 20-year muni interest rate has distorting consequences.
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