Chapter 7
An ad valorem tax is based on:
Property values
An individual who's concerned about the alternative minimum tax may find it most suitable to invest in:
Public use municipal bond
All of the following information is found in a municipal revenue bond resolution:
Restrictions on the sale of additional bonds Rate covenants Sinking-fund provisions
A double-barreled municipal bond is backed by the:
Revenues of a project and taxes of a municipality
Standard and Poor's best rating for notes is ________ and its worst rating is __________.
SP-1 SP-3.
The term all-or-none, in trading municipal bonds, applies to:
Sellers' offering terms
What type of bond would MOST likely be secured by an excise tax, cigarette tax, or gasoline tax?
Special tax bond
An investor must pay accrued interest for a secondary market purchase of:
Tax anticipation notes
If the auction for auction rate securities fails, the current holder will:
Continue to hold the securities and the interest rate will be set to the maximum rate allowed in the plan documents
is debt of the municipality that is no longer outstanding and, therefore, is not included in analyzing the debt structure of a municipal bond.
Matured debt
The taxing power of an issuer of a limited tax bond is limited to a specified:
Maximum rate
A state agency revenue bond does not have sufficient revenue to meet debt service. A provision of the indenture allows the agency to request funds from the state legislature. The legislature has the option of providing or not providing the additional funds. This is a:
Moral obligation bond
Individuals may take up to _________________ in distributions annually from their 529 plans to pay for private school tuition and books for grades K through 12—in addition to using their account proceeds for college costs (this is a new provision under the Tax Reform Act).
$10,000
Bank-qualified bonds are issued by small municipalities and, to qualify, a municipality may only issue up to _________________ annually. This is done to encourage commercial banks to invest in locally issued municipal securities. Commercial banks that purchase this type of security are permitted to deduct ____________ of the interest cost paid to depositors on the funds used to purchase the bonds.
$10,000,000 80%
A municipal bond that was issued at par is purchased by an individual in the secondary market at a price of 90. What is the tax consequence if the bond is held to maturity?
$100 ordinary income
The bonds purchased by the investor will generate yearly interest of $12,000 ($100,000 par multiplied by 12%). The fact that the bonds mature on December 1, 2041 indicates that interest payments are made every December 1 and June 1. The investor will owe 60 days of accrued interest (from June 1, the last coupon, up to but not including the settlement date of August 1). Since the yearly interest is $12,000, accrued interest would be
$2,000 (60/360 x $12,000).
Accrued Interest = (Principal x Rate x Days of Interest) / 360 = ($20,000 x 8% x 47) / 360 =
$208.88
A person may front-load a 529 plan with an initial gift of _____________ per beneficiary, which is treated as if $15,000 is being contributed each year over a five-year period. For a married couple, the amount is ________________ per beneficiary
$75,000 $150,000
______________ is the sale and purchase of bonds (or other securities) to realize a capital loss that can be offset against a capital gain.
A tax swap
Annual Debt Service$3,000,000 Annual Gross Revenues$6,000,000 Annual Operating and Maintenance Expenses$2,000,000 Step 1: Calculate the net revenue for the municipal revenue bond. Annual Gross Revenues $6,000,000- Annual O/M Expenses $2,000,000 = Net Revenue $4,000,000 Step 2: Divide net revenue of $4,000,000 by the debt service of $3,000,000 to calculate the annual debt service coverage ratio which is
1.33 to 1.
Property tax is computed by multiplying the assessed value by the millage rate. A mill equals
0.001 or $1 per $1,000 assessed value.
A municipal dealer has a customer's order to purchase bonds on an agency basis. According to MSRB rules, the customer's order must be executed at:
A price that is fair and reasonable
When a bond is purchased at a premium (106), the premium must be amortized (reduced) over its life. The premium in this example is six points, which must be amortized over its 8-year life. It must be amortized 3/4 point each year (6 points divided by 8 years to maturity). After six years, it will be reduced by 4 1/2 points (3/4 x 6). Its cost basis will, therefore, be:
101 1/2 (106 original cost - 4 1/2 points amortized premium).
Since the investor's settlement date was January 31, he owes accrued interest from January 1 to January 30 (_____ days). The buyer of a new issue must pay the issuer interest that accrues between the dated date and the settlement date, in addition to the principal amount purchased.
30
Corporate and municipal bond interest is computed on the basis of a:
30-day month and a 360-day year
An investor who purchases a municipal bond that has one year remaining to maturity is entitled to __________ days of interest at maturity.
360
Since the bonds mature on Nov. 1, we know the semiannual interest payments are made on Nov. 1 and May 1. The bonds were purchased in June, so accrued interest must be calculated from the last interest payment date, (May 1, up to but not including settlement.) Since the transaction will settle on June 17, we count 16 days in June. So the total number of days of accrued interest is 30 days for May (remember, in calculating accrued interest for municipal bonds, a 30-day month and 360-day year are used) and 16 days for June. Accrued interest of ________ days is owed to the seller.
46
the fact that municipal bond transactions are exempt from the:
5% policy.
___________________ is a short-term security and a floating rate note's interest rate would be adjusted downward with prevailing interest rates.
A TAN
______________________ is simultaneously selling one bond and purchasing another.
A bond swap
A municipal bond issue is called due to an event beyond the control of the issuer that affects the use of property (e.g., earthquakes, hurricanes, condemnation of property). This is known as:
A catastrophe call
________________________ is a sum of money given to the issuer of a new municipal bond issue along with a syndicate's bid and is not a factor in secondary-market transactions.
A good faith deposit
_________________ is the maximum amount of debt that a municipality may incur and is important in the credit analysis of a general obligation bond.
A municipality's debt limit
A municipal offering in which two or more issues of bonds have the same priority of claim against pledged revenues is referred to as:
A parity bond
would indicate a deteriorating credit situation for a municipality includes:
An increase in per-capita debt An increase in tax delinquencies An increase in personal bankruptcies
Which of the following approvals is required before a municipality can begin making payments on a moral obligation bond?
Approval by the state legislature
Roundville Bank is considering an investment in Roundville County bonds. The bonds contain a provision that permits banks to deduct 80% of the interest cost being paid to depositors on the funds used to purchase the bonds. These securities are known as:
Bank-qualified bonds
_________________ allow banks to deduct 80% of the interest cost paid to depositors on the funds used to purchase the bonds. This is done to encourage banks to invest in municipal securities. To qualify, a municipality may only issue up to $10,000,000 annually.
Bank-qualified municipal bonds
A municipality borrowing for a short-term period to finance a capital project would issue:
Bond anticipation notes
The interest paid on special assessment bonds is derived from _____________________. These bonds are issued to finance the construction of water and sewer systems, sidewalks, and streets.
Charges on the benefitted property
__________________ are factors that will affect all bond issuers and would be least useful when analyzing a specific issuer of revenue bonds.
Current interest rates
Accrued interest on new municipal bonds is calculated from the:
Dated date
________________ is used when analyzing a general obligation bond and would not be considered for a revenue issue.
Debt per capita
The number of times the earnings of a municipal facility exceeds the interest charges and principal payments of a revenue bond for a period is called the:
Debt service coverage ratio
________________ are paid first only in gross revenue pledges. It is assumed that the airport is using a net revenue pledge that results in all maintenance and operation expenses being deducted before arriving at net revenues.
Debt service expenses
The credit analysis of a general obligation bond is based on the issuer's ability to levy and collect taxes in an amount that's sufficient to cover the debt service of the issue. The main considerations are as follows:
Demographics, such as the diversification of economic activity Factors affecting the issuer's ability to pay, such as the budgetary pictures and legislative climate
The interest from bonds issued by U.S. territories, possessions, and the Commonwealth of Puerto Rico is:
Exempt from federal, state, and local taxes
According to MSRB rules, a municipal bond dealer will consider the following factors when determining a markup?
Expenses Profit Total dollar amount of the transaction
A grant anticipation note is normally paid from:
Funds received from the federal government
A bond with an 11% coupon is purchased at 103. The maturity of the bond is 20 years. The bond is callable in 10 years at par. The yield will be:
Higher if held to maturity
The provisions for the flow of funds of a revenue bond issue appear in the:
Indenture
______________________ are issued by local municipal governments to build factories or other commercial properties.
Industrial development revenue bonds
MSRB rules state that subject or nominal quotes may be given for:
Informational purposes
Municipal notes are used for:
Interim financing
An official statement for a general obligation bond says that property taxes may not be raised above a certain level. This is known as a:
Limited tax bond
Which of the following choices is Moody's BEST rating for a municipal note?
MIG 1
A project financed through revenue bonds is experiencing difficulty in that revenues are not sufficient to meet debt service payments. If, through legislative approval, the state pays interest and principal in a timely manner, the issue is MOST LIKELY:
Moral obligation bonds
When computing coverage for revenue bonds, the ratio used is:
Net revenue to debt service
An individual purchased a 10-year municipal bond at a cost of $1,050. If the individual sells the bond in five years at its amortized value, the tax consequence will be:
No capital gain or loss
A municipal bond that is issued at par is later purchased at a discount and redeemed for par at maturity. The investor's profit on the transaction is taxed as:
Ordinary income
The debt of other districts that the residents of a particular municipal district may be responsible for is called:
Overlapping debt
is that portion of the debt of other government units for which residents of a particular municipality are responsible, such as services or facilities shared by several municipalities.
Overlapping debt
Prior to the maturity of a variable-rate demand obligation, an investor has the right to receive the:
Par value plus accrued interest
___________________________ are issued to finance the construction of a facility that will be used by a private corporation. Interest earned on such bonds is often subject to the alternative minimum tax (AMT).
Private activity bonds
Industrial development revenue bonds are backed by:
The corporate guarantor
A facility is created by the issuance of industrial development revenue bonds. The bonds are backed by:
The corporation that leases the facility
____________ of a municipal bond is the date that interest begins to accrue and will not affect its marketability.
The dated date
factors to be taken into consideration when determining the markup on a municipal securities transaction include:
The dollar amount of the trade The best judgement of the dealer The fact that the dealer is entitled to make a profit NOT the financial condition of the customer.
A revenue bond is backed by a pledge of net revenues. This indicates that:
The first use of net revenues is to pay the debt service on the bonds
____________________________ fund holds monies put aside for the improvement of the facility.
The renewal and replacement
Rockland County has issued industrial development revenue bonds for the benefit of the Hudson Nail and Screw Co. In evaluating the credit quality of these bonds, an investor should look primarily at:
The security backing the industrial development revenue bond is the lease payment made by the corporation. An investor must assess whether Hudson Nail and Screw can meet this obligation by generating sufficient revenues from its primary business
When general obligation bonds are analyzed, the credit analysis will be affected by which TWO of the following factors?
The tax collection record of the municipality An evaluation of the debt to real estate value ratios in the municipality
When comparing an Albany, New York hospital revenue bond to a Buffalo, New York hospital revenue bond, you notice that they have similar maturities but the Buffalo bond has a higher yield. A possible reason for this is:
There are more hospitals located in Buffalo than in Albany
is all of the general obligation debt issued by a municipality, regardless of its purpose.
Total bonded debt
is the sum of the total debt and any unfunded debt (i.e., short-term notes) of a municipality.
Total direct debt
For trades involving municipal securities, confirmations must be sent to customers at or before the completion of the transactions (usually by the settlement date). A confirmation must include the following information:
Trade date and settlement date Description of the securities, par value, the name of the issuer, interest rate, maturity, type of bond (if not a GO bond), and pertinent call features Price and yield Amount of accrued interest, principal, and total for the transaction The capacity in which the broker-dealer acted (agent or principal) For agency trades, the amount of all remuneration (commission and concession) must be disclosed. Whether the bonds are subject to state income tax is not included on a customer's confirmation.
A customer purchases a municipal security in the secondary market at a discount. At maturity the customer will:
Treat the discount as ordinary income
If a customer places an order to buy bonds at 104 net, it indicates that the customer:
Wants to pay a maximum of 104 including any markup or commission
A municipal bond is currently trading at 92 and is callable in 10 years at par. What is the effective yield that must be disclosed on a customer's confirmation?
Yield to maturity
Municipal serial bonds are priced on the basis of:
Yield to maturity
If a security is sold at a loss, and within 30 days (prior to and after the sale), substantially the same security is purchased, the IRS, considers it a wash sale and will disallow the loss. To avoid purchasing a security that the IRS will consider substantially the same as the security sold, you should purchase bonds either by:
a different issuer or with a different coupon or maturity. The rating of the bonds would not be a factor.
The ratio of the amount of net overall debt (both direct and overlapping) to assessed value is useful in analyzing the credit risk of an issuer of general obligation (not revenue) bonds. In order for a municipal revenue bond issuer to raise funds for a project, it will conduct:
a feasibility and engineering study.
The management capability of the fiscal officers is also important for ____________________________ to insure they are able to implement the plans of the municipality.
a municipality's creditworthiness.
The state of the local economy (not the U.S. economy) is an important factor in determining:
a municipality's creditworthiness.
a general obligation bond is backed by the taxing authority and full faith and credit of the issuer. Unlike a revenue bond, which is backed by:
a revenue generating project or facility.
An accounting measure that reflects the increase in the value of an OID bond is referred to as:
accretion, not appreciation.
The upward adjustment in the purchase price of an original issue discount bond is called:
accretion.
The amount of __________________ is not a factor in a municipal bond purchase or sale.
accrued interest
Copies of official statements need not be retained since the MSRB does not have the authority to regulate issuers and, therefore, may not require the preparation of:
an official statement.
A level debt service bond issue is one in which combined ______________ and _________________ are equal.
annual interest and principal payments
Because of the tax exemption allowed on municipal bond interest, municipalities are normally able to issue bonds with coupon rates:
below those of Treasury securities.
Since the yield (10%) is higher than the coupon (8%), the bond was purchased at a discount. Since the bond was purchased in the secondary market at a discount, the interest on the bond is exempt from federal taxation but the discount will represent ordinary income at maturity. Since the investor must pay federal income tax on the ordinary income, the after-tax return will be:
between 8% and 10%.
Most corporate debt and other types of fixed-income or debt securities (i.e., municipal bonds) are not traded on an exchange, but traded:
directly between broker-dealers.
The dealer purchased the bonds at par (6% coupon at a 6.00 basis). When reoffering the bonds, the dealer's markup should be reasonable. A one-point markup (101) is considered reasonable, whereas an eight-point markup (108) is not. An offering of 5.80 represents a reduction in yield of 20 basis points and is considered reasonable. A reduction in yield of 200 basis points (6.00 basis minus 4.00 basis reoffering) is:
excessive.
The amount accreted each year is considered interest income, which may or may not be taxable depending on the type of security. The interest on an out-of-state municipal security is exempt from __________________, but subject to _______________________.
federal tax, but subject to state and local income tax.
A general obligation (GO) bond is backed by the full faith and credit of the municipality. Items that may be used to pay the debt service on GO bonds include:
fines, sales taxes, property taxes, income taxes, and licensing fees. Items such as tolls, concessions, and lease rental payments would be used to back a revenue bond.
The first coupon will be paid in 7 months. This is known as an odd (in this case, long) first coupon payment. The interest will begin to accrue from the dated date but will be paid on the:
first coupon date.
When bonds are offered firm for one hour with a five-minute recall, the offering Dealer A cannot sell the bonds to anyone but Dealer B without giving Dealer B the first opportunity to take the bonds. When Dealer A called Dealer B and said, fill or kill, Dealer A was invoking the:
five minute recall. Dealer B would now have five-minutes to take the bonds or else Dealer A would be free to sell the bonds to someone else.
Overlapping debt involves only:
general obligation borrowing.
An investor has purchased a Bristol County Public Power System revenue bond. If the power system declares bankruptcy, the bonds will:
go into default
Since the customer believes interest rates will decline, he wants to lock in a ______ yield for the next 15 years.
high
Property values, debt coverage ratios, competing facilities, and demographics are useful when examining the credit risk of a municipal bond; however, the direction of __________________ is not.
interest rates
Municipal revenue bonds do not always have:
maturity schedules that equal the useful life of the facility being built.
The bonds are being offered at a discount since the yield to maturity (6.75%) is greater than the coupon rate (6.00%). A discount bond is always priced to:
maturity.
In a 529 plan, as the beneficiary approaches college age, a suitable investment strategy is to move from growth-oriented securities (e.g., equities) to income-oriented securities (e.g., bonds and money market funds). Once the funds are being used, the account should be invested in:
money-market funds or other types of short-term investments.
Depending on the amount of income generated in the account and the age of the minor, taxes are calculated at the parents' rate. Therefore, parents may consider the purchase of _________________ in the custodian account for tax advantages.
municipal bonds
A 529 plan is a type of __________________
municipal fund security.
MIG (Moody's Investment Grade) ratings apply to:
municipal notes.
MSRB rules require that a copy of the ______________ be sent to each purchaser of a new issue. _________________ must be sent on every transaction, whether a new issue or a secondary market trade.
official statement A confirmation
The investor purchased an already outstanding municipal bond at a discount and later redeemed it for par at maturity. The profit on the transaction is taxed as ____________________. This is different from an example in which the investor purchased an original issue discount municipal bond and held it to maturity. In such an example, the profit is considered ___________________.
ordinary income interest and is exempt from federal income tax.
Debt issued between two states is not considered:
overlapping debt.
Although they are both long-term securities with short-term trading features, only VRDOs have a:
put feature that permits the holder to sell the securities back to the issuer or third party.
The premium paid on a municipal bond must be amortized over the life of the bond. If held to maturity, the cost basis is:
reduced to par value and there is no loss.
A special tax bond is financed by a tax other than an ad valorem tax, such as a tax on cigarettes, liquor, or gasoline, and A certificate of participation (COP) is a revenue bond backed by a lease payment BOTH would not:
require voter approval.
An increasing population trend and a mixture of diverse businesses (both new and established) are positive demographic indicators that reinforce the quality of general obligation issues. User fees are generally associated with ____________________.
revenue bond issuers.
Some municipal zero-coupon bonds are referred to as capital appreciation bonds (CAB). CABs are NOT suitable for investors who are:
seeking income.
When interest rates fall, a municipality may want to engage in advance refunding. In this case, the municipality will:
sell a new issue with the proceeds of the sale going into an escrow account containing U.S. government securities.
Total bonded debt is the sum of both long-term and short-term debt of a municipality plus its applicable share of overlapping debt. Overlapping debt is that portion of the debt of other government units for which residents of a particular municipality are responsible, such as:
services or facilities shared by several municipalities.
For auction rate securities, the clearing rate is the ______________ rate when an auction is successful.
settled
Accrued interest on a new municipal issue is calculated from the dated date up to, but not including the:
settlement date.
A tax-exempt money-market fund would invest in short-term tax-exempt obligations such as:
tax anticipation notes and revenue anticipation notes.
In a custodian account, the minor is technically liable for:
taxes.
The credit rating of Industrial development revenue bonds are based on the credit rating of _______________ and not on an analysis of the credit rating of the municipal government issuing the bonds.
the corporation
The interest on Industrial development revenue bonds is paid from the lease rental payments made by _____________.
the corporation.
Bond swaps may be done to change:
the coupon, maturity, quality or rating, and for tax purposes. Accrued interest is not a consideration.
The MSRB regulates the yield that must be disclosed on a client's confirmation. The yield disclosed is:
the lower of the yield to maturity or yield to call.
A double-barreled security is a municipal security that Can be paid from:
the revenues of a project and is a general obligation of a municipal government
Members of a secondary market joint account must publish:
the same offering price.
IRS rules allow for reallocation of investments in a 529 plan to be made _____________ per year.
twice
Municipal bond insurance covers both interest and principal. o If the money in a Coverdell Education Savings Account is not used by the beneficiary's 30th birthday, it can be transferred to another member of the beneficiary's family who is:
under the age of 30.
A municipal bond trader is not involved in:
underwritings of new issues.
A municipal bond purchased as an original issue discount (OID) is accreted (not amortized) each year for tax purposes based on a constant yield method (also called constant interest method), which uses the bond's _________________.
yield to maturity.
