Guidance in Setting Parameters

After entering the bond's basic characteristics—such as its maturity date, coupon rate, and call date—the next step is selecting the parameters used to construct the municipal yield curve and, when applicable, price the embedded call option.

Choosing the Most Important Pricing Parameters

• Treasury Spot-Rate Curve — Select the Treasury spot-rate curve that best represents current or historical market conditions. If you are unsure, the latest historical Treasury curve or a normal upward-sloping Treasury curve provides a good starting point.
• Implied Tax Rate — The implied tax rate adjusts taxable Treasury rates to reflect the tax advantage received by investors in municipal bonds. A fixed value of 25% applied to all maturities is a reasonable starting point. Values that decline from approximately 35% for short-term rates to 20% for long-term rates are also reasonable and often better reflect market conditions.
• Municipal Spread — The municipal spread adjusts municipal yields to reflect credit quality, liquidity, and other market factors. If no better information is available, begin with a spread of 0 basis points.
• Interest-Rate Volatility — Volatility is an important assumption in the interest-rate models used to value callable bonds. A value near 15% is a reasonable starting point when using the default Black-Karasinski short-rate model.

For a more complete discussion of municipal bond pricing concepts and the methods used by this application—including non-callable and callable bond valuation, municipal yield-curve construction, implied tax rates, municipal spreads, interest-rate volatility, and option-adjusted spreads (OAS)—see Municipal Bond Pricing Concepts and Methods.