The Municipal-Over-Bonds (MOB) Spread is the difference in yield between a Municipal Bond and a Treasury Bond with the same maturity. The MOB spread reflects the difference between the interest rates of Muni Bonds, which are typically issued by State and Local Governments to fund operations and finance projects, and Treasury Bonds, which are issued by the Federal Government. The spread can be influenced by various factors such as changes in interest rates and the tax-exempt status of Municipal Bonds.
Municipal Bonds are generally considered to have low default risks compared to Corporate Bonds and their yield can be higher even if they receive the same rate as Treasury Bonds due to their tax-exempt status. Conversely, Treasury Bonds are not callable while most municipal bonds have call options. When interest rates fall, noncallable Bonds outperform callable Bonds, and reverse is the case when interest rates rise, thereby affecting the MOB spread. The composition of the Municipal Bond Index, which is updated regularly to include new Bonds and remove older ones, can also impact the spread.
Traders can take advantage of the MOB spread by taking a short position in Treasury contracts and a long position in Municipal Bonds when the spread widens, or vice versa when the spread narrows. By doing so, they can profit from changes in the spread and potentially benefit from the low default risk and tax-exempt status of Municipal Bonds.
The Municipal-Over-Bonds Spread is a useful tool for traders to monitor the relationship between the yields of Municipal Bonds and Treasury Bonds and potentially profit from changes in the spread. The spread can be impacted by various factors, including interest rates, the tax-exempt status of Municipal Bonds, and the composition of the Municipal Bond Index.
With the increasing interest in the Nigerian Bond market and public demand for Local Government autonomy, it is just a matter of time for us to see Municipal councils with the required financial transparency and corporate governance discipline to approach the market for funds to finance infrastructural projects.