My friend bought bonds at a premium and his broker amortizes this premium from the purchase date up to the maturity date. That premium amortization reduces my taxable interest every year. When the bond is callable (almost always at par value), then it is amortized over a much shorter period (from the purchase date up to the first call date), and the premium amortization is that much higher given the shorter period. I can appreciate why using a shorter period (up to the first call date) on a taxable bond is preferable as it maximizes the premium and therefore reduces further the amount of taxable interest every year.
On a tax-exempt bond however, using a shorter period to amortize the premium is another story. The larger premium amortization every year makes no difference whatsoever since all interest, with or without premium amortization, is tax-exempt anyway. Should he not amortize that bond premium over the remaining life of the bond (i.e. from purchase date to maturity date)? The premium amount amortized every year would then be a bit smaller, creating a capital loss in the event the bond is called (or sold before the call date). By amortizing the premium on a tax-exempt bond up to the earliest call date, there is zero capital loss at the time of that call. By amortizing it up to the maturity date, the “Yield-To-Worst” number presented to him when he purchased that bond can be realized. Should he not do it this way?
