What Is Municipals-Over-Bonds Spread? (MOB)
Municipals-over-bonds spread (MOB) refers to the difference between the yields from municipal, or municipal bonds, and Treasury bonds which have the same time to maturity.
The MOB spread is sometimes used for determining tax strategies. MOB spread is influenced by interest rates and the tax-exempt status of the municipal or Treasury bonds.
Understanding Municipals-Over-Bonds Spread (MOB)
Municipals-over-bonds spread (MOB) expresses the relationship between the yields from an index of municipal bonds and those from a Treasury bond (T-bond).
- Municipal refers to the municipal bond contract.
- Bonds refer to the Treasury bonds contract.
- The spread means the difference between these two contracts.
The spread increases when the difference between the municipal bonds contract and the Treasury bond contract widens. This widening happens when the yields of the municipal contract are rising more quickly than the Treasury bond contracts. The spread narrows when the return of the Treasury bond contract increases more rapidly than the municipals index.
Most MOB spread calculations actually use the yield implicit in futures prices for municipal bonds and Treasuries listed on the Chicago Board of Trade (CBOT). The MOB spread is mostly a comparison of the interest rate spread between federal government debt, or Treasuries, and state and municipal debt.
Municipal bonds are mostly nontaxable, while Treasury bonds are taxable federally. This difference creates a difference in their actual yields, even if they earn at the same interest rate. Assuming that both products receive at the same rate, municipal bonds will return more to the investor because they are usually not taxed, where Treasury bond earnings are.
Interest Rates and the Municipals-Over-Bonds Spread
Interest rates influence the Municipals-over-bonds spread (MOB) in several ways. The municipals index is an index of municipal bonds which are changed regularly to incorporate new municipal bonds and remove older ones. The composition of the index determines how the index is affected by interest rates. Varying mixes of different municipal bonds will be more responsive to interest rates than others.
The Treasury contract tracks the price of a single 30-year Treasury bond.
Most municipal bonds are callable, while the Treasury bond is not callable. When interest rates go up, callable bonds outperform noncallable bonds and MOB widens. However, when interest rates go down, noncallable bonds outperform callable bonds and the spread narrows.
Traders use these differences in taxable and nontaxable status along with callable and noncallable status to take positions with municipal bonds and Treasuries.