Series 7 Unit 6
Assistance with the Official Statement
As part of its financial advisory services to an issuer, a municipal securities dealer may help prepare the final official statement for a new issue. If it prepares the official statement, the adviser must make a copy of that statement available to the managing underwriter promptly after the award is made and at least two days before the syndicate manager delivers the securities to the syndicate members.
MSRB Rule G-17
"In the conduct of its municipal securities or municipal advisory activities, each BD and municipal advisor shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice."
An unqualified legal opinion means that the bond counsel found no problems with the issue. A qualified opinion means that the issue is legal, but certain contingencies exist.
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Prepaid Tuition Plans
Allow donors to lock in future tuition rates at today's prices, thus offering inflation protection.
Municipal Financial Professionals (MFPs)
An associated person of a BD who is primarily engaged in muni securities activities other than retail sales to individuals. The MFP designation also includes anyone who solicits muni securities business for the BD or is in the supervisory chain above another person with the MFP designation. This can include senior officials of the BD or executives, or management committee members of the BD. Of note, the MSRB is clear that anyone designated as an MFP is subject to the rules regarding political contributions and required to report those contributions to the MSRB, as well as any other payments made to a state or local political party. be sure you know the exception for de minimis contributions.
Build America Bonds
BABs created in 2009 recovery act to assist in reducing costs to issuing municipalities and stimulating the economy. While bonds to find muni rojects have traditionally been sold in the tax-exempt arena, BABs are taxable obligations. Bondholders pay tax on interest received from BABs. Tax credits are provided in lieu of the tax-exempt status usually afforded the interest on muni securities. These bonds attracted investors who would normally not buy tax=exempt bonds and expanded the pool of investors to include those in lower-income tax brackets, investors funding retirement accounts where tax-free securities would normally not be suitable, public pension funds, and foreign investors. There are two types of BABs issued: Tax Credit BABs Direct Payment BABs
Other types of quotes continued
BW/OW: Municipal dealers are called upon regularly to provide current quotations for municipal securities they do not have in inventory. Municipal bonds are not listed on any exchange, they do not have the quote and price transparency as listed securities. When a customer of a municipal firm si looking for a specific bond, the dealer will actively solicit offers to sell from the marketplace. If the customer has bonds to sell, the dealer will actively solicit bids from the marketplace for those bonds. Test Topic Alert** Under MSRB rules, any indication of interest or solicitation by a municipal dealer (such as bid wanted or offer wanted) would be considered a quotation request. The term quotation means any bid for or offer of municipal securities. Multiple markets in the same security: There are some very large financial organizations that have more than one BD under their control. If they publish a quote for a municipal security, it must be clear that this represents only one quote instead of two independent quotes. To do otherwise would imply a greater liquidity in the bonds.
Taxable Muni Bonds
Build America Bonds (BABs)
Certificates of Participation
CoPs are a form of lease revenue bond that permits the investor to participate in a stream of revenue from lease, installment, or loan payments related to the acquisition of land or the acquisition or construction of specific equipment or facilities by the muni.
Direct Payment BABs
Direct Payment BABs provide no credit to the bondholder but instead provide the muni issuer with payments from the US Treasury equal to 35% of the interest paid by the issuer. TTA*** The BABs program expired on Dec. 31 2010, without being renewed. However, in the short time that muni's were permitted to issue BABs, billions of dollars of capital had been raised to fund muni projects throughout the US and many of these issues will remain outstanding for a number of years. Finally, it should be noted that the program could be reinstated in the future, and the types of BABs offered and the credits they provide could be amended as well.
MSRB Rule G-22 Control Relationships
Disclosure of Control: a muni securities firm that has a control relationship with respect to a muni security is subject to additional disclosure requirements. A control relationship exists if the dealer is controls, is controlled by, or is under common control with that security's issuer. Example: An officer of a muni dealer sits on the board of directors of an Issuer. The dealer must disclose the control relationship to the customer before it can affect any transaction in that security for that customer. Although, initialy, this disclosure can be oral, the dealer must make a written disclosure at or before the transaction's completion. The disclosure is made on the confirmation . If the transaction is for a discretionary account, the customer must give express permission before the transaction can be executed.
Double-Barreled Bonds
Double-Barreled Bonds are revenue bonds that have characteristics of GOs. Interest and principal are paid from a specified facility's earnings. However, the bonds are also backed by the taxing power of the state or muni and therefore have the backing of two sources of revenue. Although they are backed primarily by revenues from the facility, double-barreled bonds are rated and traded as GOs.
Basis of Compensation
Each financial advisory relationship must be documented in writing before, upon, or promptly after its inception. This document establishes the basis of compensation for the advisory services to be rendered.
The BD as Financial Advisor
Financial Advisors: The MSRB has established ethical standards and disclosure requirements for muni securities dealers that act as financial advisors to muni securities' issuers. A financial advisory relationship exists when a muni dealer provides financial advisory or consulting services to an issuer with respect to a new issuer for a fee or other compensation. This includes advice regarding the structure, timing, and terms of, as well as other matters concerning, the issue or issuer. Bringing a new issue public, whether it is equity or debt, is called underwriting. In the case of muni bonds, the disclosure document used is an official statement rather than a prospectus.
TTA***
For exam purposes, you NEVER recommend muni bonds to investors UNLESS they are in the higher tax brackets. Any question dealing with a low tax bracket client will never have a muni bond as a suitable recommedation.
Key Municipal Bond Calculations
Many of the muni bond calculations are the same as those covered with corporate bonds. -nominal (coupon) yield -current yield (CY) -Yield to maturity (YTM) -Yield to call -accrued interest
Muni Bond Capital Gains and Capital Losses
Muni bonds have capital Gains and Losses just like other investments. This gain/loss are NOT TAX-FREE, only the interest payments are tax free.
MSRB Rules
Rules and regulations applicable to all firms and individuals having to so with muni securities are written by the MSRB. MSRB: The Securities Acts Amendments of 1975 established the MSRB as an indepenent SRO. The MSRB governs the issuance and trading of muni securities. The rules require muni securities underwriters and dealers to protect investors' interests, be ethical in offering advice, and be responsive to complaints and disputes. The MSRB rules apply to all firms and individuals engaged in the conduct of muni securities business. The MSRB does not regulate issues.
The Calculation for accrued interest
The calculation to determine accrued interest assumes all months -- even February-- have 30 DAYS. All corporate and muni bonds use the 30-day-month count. Therefore, for purposes of this calculation, the year contains 360 days. EXAMPLE: A F&A muni bond traded regular way on Monday, March 5, the number of days accrued interest is calculated as follows: February = 30 days March 5 trade = 6 days (march 1, 2, 3, 4, 5, 6) march 7 is the settlement date so the days accrue UP TO BUT NOT INCLUDING the settlement date. TTA* Recap for calculating accrued interest follows: -Corporate, agencies, and municipals use 30 day month 360 day year -US Treasury Securities use actual day months 365day year When counting days: -go back and include the last interest payment date -go up to but not including the settlement date.
Call Features
The longer the call protection, the more marketable the bond. That means non-callable bonds are the most marketable.
Block Size
The typical block for a muni bond trade is $100,000. Trades in smaller amounts are not as marketable.
MSRB Rule G-15
This rule requires members to provide customers with written confirmation of transactions. One part worth mentioning here deals with computing the yield and dollar price. We know that calling a premium bond invariably results with a lower yield to the investor than holding the bond to maturity. Therefore, this rule states that in computing yield and dollar price, -The yield or dollar price computed and shown shall be computed to the lower of call or nominal maturity date; -for purposes of computing yield to call or dollar price to call, only those "in whole calls" are included.
Lease-Rental Bonds
Under a typical lease-rental (or lease-back) bond arrangement, a municipality issues bonds to finance office construction for itself or its state or community. *Example: A muni might issue bonds to raise money to construct a school and lease the finished building to the school district. The lease payments provide backing for the bonds. Lease payments come from funds raised through special taxes or appropriations, from the lessor's revenues, such as the school's tuition or fees, or from the muni's general fund.
Adjusting the Cost Basis of Municipal Bonds
Upon disposition of a muni bond, either with a sale or redemption at maturity or call, determining if an investor has a capital gain or capital loss requires knowing the cost basis. If and how cost basis is adjusted for municipal bonds depends first on if the bond was purchased at a premium or a discount.
Municipal Bond Maturities
***Term Maturity: All principal matures at a single date in the future. Term bonds are quoted by price and are called dollar bonds. To facilitate the retirement of its bonds, a corporate or municipal issuer may establish a "SINKING FUND" operated by the bonds' trustee. The trust indenture often requires a sinking fund, which can be used to call bonds, redeem bonds at maturity, or buy back bonds in the open market. To establish a sinking fund, the issuer deposits cash in an account with the trustee. B/c a sinking fund makes mone available for paying off the bonds, it can aid the bonds' marketability and safety. ***Serial Maturity: bonds within an issuer mature on different dates according to a predetermined schedule. Serial bonds are quoted on the basis of their yield to maturity (basis), to reflect the difference of maturity dates within one issue. ***Balloon Maturity: An issuer pays part of a bond's maturity before the final maturity date, but the largest portion is paid off at maturity. Take Note*** A balloon maturity is a type of serial maturity. Most municipal bonds are issued serially.
*****Broker-dealers acting as financial advisors to a municipality regarding a municipal issue are prohibited by Municipal Securities Rulemaking Board Rule G-23 to also act as underwriters for the same issue, regardless of whether the underwriting process has been done by competitive bid or was negotiated
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Debt service is the total of interest and principal payable by the issuer plus any amount required to be deposited into a sinking or surplus fund.
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Municipal Securities
A maturity of less than five years are considered municipal notes. A maturity of more than 5 years are municipal bonds. General Obligation Bonds (GO): backed by the full faith, credit, and TAXING powers of the municipality. GOs issued by local government units are most often backed by ad valorem taxes. Revenue Bonds: backed by the revenues generated by the municipal facility the bond issue finances. Sometimes that revenue comes from special taxes, such as excise taxes or other specified non-ad valorem taxes.
Moral Obligation Bonds
A moral obligation bond is a state or local issued, or state or local agency issued bond. If revenues or tax collections backing the bond are not sufficient to pay debt service, the state legislature has the authority to appropriate funds to make payments. The potential backing by state revenues tends to make the bond more marketable, but the state's obligation is not established by law; it is a moral obligation only. If a moral obligation bond goes into default, the only way bondholders can be repaid is through LEGISLATIVE APPORTIONMENT. The issuer's legislature would have to apportion money to satisfy the debt but is not legally obligated to do so. All moral obligation bonds are considered revenue bonds.
Municipal Bonds: Bona Fide (Firm) Quotes
A municipal dealer gives, distributes, or can publish a quotation for a security, and that quote must be "bona fide". To be considered a bona fide quote, the dealer must be prepared to trade the security at the price specified in the quote and under the conditions and restrictions (if any) accompanying the quote. A bona fide quote: -must reflect the dealer's best judgment and have a reasonable relationship to the fair market value (FMV) for that security, and -may reflect the firm's inventory and expectations of market direction. A quotation need not represent the best price, but it must have a reasonable relationship to the FMV. A quote may take into consideration other factors, such as the dealer's inventory and expectation of market direction. If the dealer distributes or publishes the quotation on behalf of another dealer, it must have reason to believe that the quote is bona fide and based on the other dealer's best judgment of FMV. Dealers can't knowingly represent a quote made by another municipal securities dealer. Quotations are always subject to prior sale or change in price. Any means of communication, including print, voice, electronic media, can be used to disseminate, distribute, or publish quotations. Take Note** Municipal dealers can make offers to sell securities by providing quotes without owning the bond. The dealer, however, must know where to obtain the bonds if such offers are accepted.
Section 529 Plans
A municipal fund security. 529 plans are a tax-advantaged savings plan offering benefits to those saving for future education costs. Prepaid Tuition plans and College Savings plans. Both funded with after-tax dollars, and earnings grow tax-deferred. Withdrawals taken for qualified education expenses are generally tax-free. If the money is used for anything other than qualified education expenses, the earnings portion of the distribution will be taxable on the federal (and possibly state) income tax return in the year of the distribution. Also, there is a 10% tax penalty on the earnings portion of your distribution. There are a couple of exeptions to the 10% penalty. The penalty is usually not charged if you terminate the account b/x your bene died or became disabled. Also waived if the bene received a scholarship. ANY person can open a 520 plan for a future student, the donor does not have to be related to the student.
Calculating a Municipality's Net Total Debt
A municipality's net total debt can be calculated as follows: Self supporting debt - sinking fund accumulations = NET DIRECT DEBT + overlapping debt = NET TOTAL DEBT A question might ask about what is or is not included in the various categories on the debt statement. A good rule: for any category that uses the word NET, self-supporting debt and sinking fund accumulations are not included. For instance, net total debt includes all GOs and overlapping debt but does not included the self-supporting and sinking fund accumulations. Do not expect a calculation question on this topic.
Which of the following statements describing Section 529 plans is true?
A) The fees associated with them are generally the same from state to state. B) Most state college savings plans require either the owner or the beneficiary of the plan to be a state resident. C) They can only be opened for children under the age of 18. D) The maximum lifetime contribution varies from state to state. Answer is D E: The features of Section 529 plans, including their contribution limits and fees, vary widely from state to state. Section 529 plans have no age limits as to participation; they are open to both children and adults who plan to attend college or graduate school. For college savings plans, there is no state residency requirement for either owners or beneficiaries of Section 529 plans.
An investor receiving a quote of 102 for a municipal security is probably interested in
A) a term bond. B) a bond anticipation note. C) a serial bond. D) a general obligation bond. Answer is A E: A quote of 102 is referred to as a dollar quote ($1,020) rather than a yield quote. The most common dollar bonds are those with a term maturity. The other choices are most often quoted on a yield basis rather than a price basis.
Achieving a Better Life Experience (ABLE) Accounts
ABLE accounts are tax-advantaged savigns accoutns for individuals with disabilities and their families. They were created as a result of the passage of the ABLE act of 2014. The bene of the account is the account owner and income earned by the account is not taxed. ABLE Act limits eligibility to individuals with significant disabilities where the age of onset of the disability occured before turning age 26. If an individual meets the age/onset criteria and is also receiving benefits either through social security insurance and/or social security disability insurance, the individual is automatically eligible to establish an ABLE account. Only one ABLE account per person is allowed. Contributions to these accounts can be made by any person including the account bene themselves, as well as family and friends, must be made using after-tax dollars and is not tax deductible for purposes of federal income taxes. Some states allow income tax deductions for contributions made.
Auction Rate Securities (ARS)
ARS are debt securities that have interest rates that are periodically reset through Dutch auctions, typically every 7, 14. 28, or 35 days. ARS are generally structured as bonds with long-term maturities (20-30 years). Munis and public authorities, student loan providers, and other institutional borrowers first began using ARS to raise funds in the 1980's. ARS were marketed to retail investors who were seeking a cash-equivalent investment that paid a higher yield than money market mutual funds or certificates of deposit, although ARS did not have the same level of liquidity as those other instruments. Interest-rate auctios for ARS failed after the 2007 financial market crash. ARS market collapsed in February 2009. . There has NOT been a new issue ARS since 2007, but the amount of outstanding issues is in the billions of dollars.
Computing Accrued Interest
Accrued interest is calculated from the last interest payment date up to but not including the settlement date (2 business days after the trade date). The buyer owns the bond on the settlement date, which means that the interest starting from that day belongs to the buyer and the previous 6 months interest is credited to the seller. The bond cost to the buyer and the proceeds to the seller include accrued interest. Accrued interest increases the bond cost to the buyer and the proceeds to the seller.
College Savings Plan
Allows the donor to invest a lump sum or make periodic payments. The money is typically invest into target-date funds. As the target date approaches (the date the money is needed) the portfolio gets more conservative. When the student is ready for college, the donor withdraws the amount needed to pay for qualified education expenses. These plans do have investment risk. Up to $10,000 per year can be used for K-12 -College savings plans may be set up in more than one state, though the allowable contribution amount varies from a low of $235,000 to a high of $529,000 -There is no age limitations for contributions or distributions -There are no income limitations on making contributions to a 529 plan -Contributions may be made in the form of periodic payments, but contributions follow the tax rules for gifts. Thus, unless willing to pay a gift tax, contributions are limited to an indexed maximum amount ($15,000 in 2019) per year per donor. Section 529 plans have a five-year election that allows a donor to contribute 5 times that amount in one year (a spouse can do the same to the same recipient), but then they may make no more contributions for 5 years. -There are few restrictions on who may be the first bene of a 529 plan. However, if the bene is redesignated, the new bene must be a close family member of the first. -Just as with other muni securities, an OS must be delivered to prospective investors. The assets int he account remain the property of the donor, even after the bene reaches legal age. However, if the account is not used for higher education, the IRS concludes that the plan was not established in good faith, it may impose fines and other sanctions. This would generally mean the earnings in the account are taxed at ordinary income rates with an additional 10% penalty. Plan assets remain outside the owner's estate for estate tax puproses. ***Take Note: B/c 529s are state-sponsored, individual states have their own version of the plan. - -
MSRB Rule G-21 Advertising
Any material designed for use in the public media is considered Advertising. This includes abstracts and summaries of the OS; offering circulars; reports; market letters; and form letters, including professional, product, and new issue advertisements. A muni securities principal or general securities principal of the dealer must approve all advertising before use, and a copy of each advertisement must be kept on file for 3 years.
New Housing Authority Bonds
Are for new housing projects. Local housing authorities issue NHAs to develop and improve low-income housing. NHAs are backed by the full faith and credit of the US Government. NHAs are sometimes called Public Housing Authority Bonds PHAs. B/c of their federal backing, they are considered the most secure of all municipal bonds. PHAs are backed by the rental income from the housing. If the rental income is not sufficient to service the debt, the federal government makes up any shortfall. Note that these bonds are not considered to be double-barreled. To be double-barreled, a bond must be backed by more than one muni revenue source. In this case, the second backing is the fed gov. TTA** PHAs are the only muni backed in full by the US Gov. They are also called Section 8 bonds.
Calculating Tax Benefits
As stated earlier, in most cases, interest received from muni bonds is free of federal income tax. Furthermore, if the investor resides in the issuer's state, it is generally free of state income tax as well. Assume an investor has $2,000 to invest. If she purchases at par one corporate or government bond of standard size ($1,000) with a 10% nominal (coupon) yield, she would receive $100 per year, paid by 2 semiannual interest checks of $50. For purposes of this example, assume that she is in the 28% federal income tax bracket.. An individual in the 28% tax bracket pays tax on any additional income earned at a rate of 28%. Therefore, on the $100 in interest she received earlier, she would pay the IRS $28 (28%) and keep the other $72. The other $1,000 she had available to invest was used to purchase a $1,000-par value muni bond with a 7.5% nominal yield. She would receive $75 annually on that bond paid, by two semi annually $37.50. The 10% bonds, on which the interest is taxable, would net $72 per year after taxes. Of the $75 interest received for the 7.5% muni, none of it is taxed. The whole amount is kept. Therefore, a client in the 28% tax bracket should purchase 7.5% muni bonds before 10% corporate bonds. The taxable equivalent yield of a 7.5% tax-free bond for this investor in the 28% tax bracket would be the tax-free yield divided by (100% - tax bracket). In this case, 7.5 (100-28) = 0.72. That equals 10.42%, so it is obvious that the 7.5% muni bond will provide a higher after-tax return. When answering a tax-equivalent yield question, keep in mind that the muni yield will always be lower than the taxable bond.
Feasibility Study
Before issuing a revenue bond, an issuer will engage various consultants to prepare a report detailing the economic feasibility and the need for a particular project. (eg a new bridge or airport). The study will include estimates of revenues that will be generated and details of the operating, economic, and engineering aspects of the proposed project.
Broker's Broker
Firms that exist to assist other firms find buyers or sellers of muni bonds. Perform this duty in both the primary and secondary market transactions. These firms are known as a Broker's Broker. These firms deal primarily with other muni securities firms acting as their agents. They will also represent institutions, but never have any dealings with public customers. A major reason these firms exist is b/c the market for most muni bonds is quite thin. That means not a lot of trading is going on. Example: Your BD specializes in MFs. From time to time it has a customer wishing to make a small purchase of muni bonds. One of your firm's clients has just inherited $500,000 in State M general obligation bonds and wishes to sell them. The size of this trade is far beyond anything your firm is capable of placing. Your firm needs help in finding buyers for these bonds so it turns to a broker's broker. Acting on behalf of your firm as its agent, the broker's broker knows the marketplace and which muni dealers or institutions might be suitable candidates for those GO bonds. For performing in this role, the broker's broker earns a commission. TTA*** One of the features of using a broker's broker is anonymity. Your firm does not disclose the identity of your customer and the broker's broker does not disclose the identity of the buyer of your client's bonds.
Sources of Funds
GOs are backed by the issuing municipality's taxing power. Bonds issued by states are backed by income taxes, license fees, and sales taxes. Bonds issued by towns, cities and counties are backed by property (ad valorem) taxes, license fees, fines, and all other sources of revenue to the municipality. In many states, the annual motor vehicle tag is based on an assessed value. School, road, and park districts may aslo issue municipal bonds backed by property taxes. B/c the property of the residents is being taxed, GO's frequently REQUIRE VOTER APPROVAL.
GOs Issues
GOs are municipal bonds issued for capital improvements that benefit the entire community. Typically, these projects do not produce revenues, so principal and interest must be paid by taxes collected by the municipal issuer. Because of this backing, GOs are known as full faith and credit issues.
Industrial Development Revenue Bonds
IDRs or IDBs, issued by munis to construct facilities or purchase equipment, which is then leased to a corporation. The muni uses the money from lease payments to pay the principal and interest on the bonds. The ultimate responsibility for the payment of principal and interest rests with the corporation leasing the facility. Therefore, the bonds carry the corporation's debt rating. Some of these bonds are subject to the alternative minimum tax (AMT).
GO Bond Analysis
INCOME OF THE MUNICIPALITY The following is primary sources of municipal income -Income and sales taxes are major sources of state income -Real property taxes are the principal income source of counties, and school districts are the largest source of city income -City income can include fines, license fees, assessments, sales taxes, hotel taxes, city income taxes, utility taxes, and any city personal property tax. GENERAL WEALTH OF THE COMMUNITY B/c GOs are backed primarily by tax revenues, their safety is determined by the community's general wealth, which includes the following demographic data -Property Value -Retail sales per capita -Local bank deposits -Diversity of industry in its tax base -Population growth or decline A GO issuer's taxing power enables it to make principal and interest payments through all but the most unusual economic circumstances. CHARACTERISTICS OF THE ISSUER A quantitative analysis focuses on objective information regarding a municipality's population, property values, and per capita income. A qualitative analysis focuses on subjective factors that affect a municipality's securities. The community's attitude toward debt and taxation, population trends, property value trends, and plans and projects being undertaken in the area are all relevant considerations. DEBT LIMITS To protect taxpayers from excessive taxes, statutory debt limits may be placed on the overall amount of debt a municipality can have. Suppose a city's total debt is limited to 5% of the estimated market value of all taxable property within the city's boundary. The total value of those properties multiplied by 5% would be the city's statutory debt limit. A bond's official statement discloses how close total outstanding debt, including newly issued debt, comes to its statutory debt limit. A state constitution or city charter can also limit the purpose for which a city may issue bonds. Often, a city may issue bonds to finance capital improvements only if those bonds mature within the expected lifetimes of the improvements. This provision ensures that the city will not owe money on a facility when it becomes obsolete. AD VALOREM TAXES Property taxes are based on a property's assessed valuation. Assessed valuation is a percentage of the estimated market value. That percentage is established by each state or county and varies substantially. The market value of each piece of property is a county is determined by the county assessor, who relies on recent sale prices of similar properties, income streams, replacement costs and other information. B/c the real property tax is based on the property's value, it is said to be an ad valorem, or per value, tax. The tax is a lien on the property, which means property can be seized if the tax is not paid. GOs, backed by the power to tax and seize property, are considered safer than revenue bonds and have lower interest rates. Property taxes are generally based on a millae rate. The assessed value is multiplied by that millage rate and the result is the amount of tax. One mill is 1/10 of a cent, or $0.001.
Municipal Bonds purchased at a discount
If a muni bond is purchased at a discount, the discount is accreted. Accretion is the process of adjusting the cost basis back up to par. It is the reverse computation of amortization. The tax treatment is more complicated. The actual tax effect of accretion depends on whether the bond waas purchased as an original issue discount (OID) or an issue purchased at a discount in the secondary market. Accretion: -increases cost basis -increases reported interest income Example: A customer buys a 5% muni bond with 10 YTM at 90. The amount of the annual accretion is $10 per bond. (10 point discount / 10 YTM). Each year, the cost basis is adjusted upward by one point. At maturity, there is no reported capital gain. Example: Assume a customer buys a 5% muni bond with a 10 year maturity at 90 in the secondary market. 5 years later, the customer sells the bond at 97. What are the tax consequences? The annual accretion of $10 per bond is taxable each year as ordinary income. The customer's cost basis at the time of sale is 95. When sold at 97, the customer has a capital gain of $20 per bond.
Flow of Funds in a Net Revenue Pledge
In a net revenue pledge, total receipts from operating the facility are usually deposited in the REVENUE FUND., and funds are disbursed as follows: -Operations and Maintenance. Used to pay current operating and maintenance expenses; remaining funds are called net revenues -Debt service account. Used to pay the interest and principal maturing in the current year and serves as a sinking fund for term issues. -debt service reserve fund. Used to hold enough money to pay one year's debt service -Reserve maintenance fund. Used to supplement the general maintenance fund -Renewal and replacement fund. Used to create reserve funds for major renewal projects and equipment replacements. -Surplus (sinking) fund. Used for a variety of purposes, such as redeeming bonds or paying for improvements. If the issuer has not pledged to pay operating and maintenance expenses first, debt service is the priority expense. When debt service is paid first, the flow of funds is called a gross revenue pledge. The debt service includes current principal and interest due, plus any sinking fund obligations. If revenues exceed operating and other obligations, the money is usually placed in a surplus fund.
Coupon
In genera, the higher the coupon, the more marketable the bond.
Dollar Price
In general, bonds with a lower dollar price are more marketable.
Maturity
In general, the shorter the time until maturity, the more marketable the bond is.
Types of Revenue Bonds
Industrial Development Revenue Bonds Lease Rental Bonds Certificates of Participation (COPs) Double-Barreled Bonds Special tax bonds New Housing Authority Bonds
AMT Bonds
Industrial revenue bonds are issued for a corporations benefit. The interest on these NONPUBLIC purpose bonds may be taxable b/c the act reserves tax exemption for public purposes. B/c theses bonds are used for a nonpublic purpose, the interest income may be subject to the alternative minimum tax (AMT) AMT enacted in 1969, to make certain high income taxpayers do not escape paying taxes. Certain items receive favorable tax treatment. These items must be added back into taxable income for the AMT. These tax preference items include: -tax-exempt interest on private purpose, nonessential government service muni bonds -certain costs associated with DPPs, such as R&D costs and excess intangible drilling costs -local tases and interest on investments that do not generate income. -accelerated depreciation on investment property Private muni bonds are included in this list. Take Note*** The language in the Internal Revenue Code (IRC) says that taxpayers are required to add the excess of the AMT over the regular tax to determine their total tax liability.
Municipal Bond Tax Calculations
Interest Payments: -The interest on a muni security is exempt from federal income tax. These are called tax-exempt or tax free investments. B/c of this, munis usually have lower interest than US Government bonds. The Tax Reform Act of 1986 restricted the federal income tax exemption of interest for muni bonds to public purpose bonds, which are bonds issued to finance projects that benefit citizens in general rather than particular private interests. If a bond directs more than 10% of its proceeds to private parties, it is considered a private activity bond and is not automatically granted tax exemption. Take Note***Unless stated to the contrary, you can safely assume that any GO bond on the exam is for a public purpose.
Original Issue Discount (OID) Bonds
It is not unusual to have a muni bod issued at a discount on its initial public offering. The reasons for this are beyond the scope of the exam. The tax consequences, however, are not. For an OID bond, the IRS considers the discount to be part of the issuer's payment of interest. Therefore, the accretion on a OID bond is tax-free. Let's look at an example. EXAPMLE: An investor buys a newly issued 5% muni bond with 10YTM at 90. B/c the bond was purchased as OID, the reported interest income would be $60 per bond ($50 plus annual accretion of $10). B/c interest income on muni bonds is tax-free, the accretion has no tax effect.
Fair Prices and Commissions Rule G-30
Just as corporate securities follow the FINRA 5% policy, muni securities come under MSRB's Rule G-30 with similar characteristics. Remember, muni securities are exempt from FINRA policy. That fact is frequently tested on the exam. Similar to FINRA rules, BDs can't charge a commission and a markup or markdown on the same transaction. The marketability of a muni bond plays a key role in determining fair prices and commissions. The MSRB rule states the markups or markdowns or commissions that muni securities dealers charge must be fair and reasonable and listed on the customer confirmation, taking into account all characteristics of a trade such as: -FMV of the securities at trade time -Total dollar amount of the transaction -any special difficulty in doing the trade -the fact that the dealer is entitled to a profit Block size ertainly affects the total dollar amount of the trade as well as the ease with which the trade is made. As a General rule, the more marketable the muni security, the lower the profit to the muni dealer. Reasonable compensation differs from fair pricing. A dealer could limit its profit on a transaction to a reasonable level and still violate this rule if the dealer fails to consider market value.
Municipal Bond Insurance
Muni bond issuers can insure their securities' principal and interest payments by buying insurance from a number of insurers. This will generally improve the marketability of the bond. Among those specializing in insuring muni issues are National Public Finance GUarantee Corp. Financial Guaranty Insurance Company, Assured Guaranty Corporation, and AMBAC Indemnity COrporation. While AMBAC is not currently insuring new muni issues, there are many AMBAC-insured muni bonds still outstanding. Insured bonds are generally issued with lower coupon rates because investors will accept lower rates of return for the added safety insurance affords. In addition, the cost of insurance may also lessen the yield a muni issuer is willing to pay. Many small issues of muni bonds are not rated b/c the cost to rate a bond can be expensive. Instead, many issuers will insure the bond for principal and/or interest. When a bond is insured, MSRB rules require of the certificates accompanied by evidence of insurance, either on the face of the certificates or in a separate document. The effect of the bond insurance is that ***both interest and principal ill be paid as scheduled, over time through the life of the bond.*** the idea is that the bondholder should not see a problem. The insurer will just take up the liability and run with it not missing a beat.
Municipal Notes
Municipal Anticipation Notes are short-term securities that generate funds for a muni that expects other revenues soon. Usually, muni notes have less than a 12-month maturity, although maturities may range from 3 months to 3 years. B/c of their short-term nature, interest and principal is paid at maturity. That is just another way of saying that they are issued at a discount. Muni notes fall into several categories: Tax Anticipation Notes(TANs) to finance current operations in anticipation of future tax receipts. This helps munis to even out cash flow between tax collection periods. Revenue Anticipation Notes (RANs) are offered periodically to finance current operations in anticipation of future revenues from revenue-producing projects or facilities. Tax and Revenue Anticipation Notes are a combination of the characteristics of both TANs and RANs Bond Anticipation Notes (BANs) are sold as interim financing that will eventually be converted to long-term funding through a sale of bonds. Tax-exempt Commercial Paper is often used in place of BANs and TANs for up to 270 days, although most maturities are 30,60,and 90 days. Construction Loan Notes (CLNs) are issued to provide interim financing for construction of housing projects. Grant Anticipation Notes are issued with the expectation of receiving grant money from the federal government.
Municipal Bond Quote Rules
Municipal bonds are bought and sold in the OTC market. NOT listed on stock exchanges. Securities Acts Amendments of 1975, the MSRB was created to regulated securities professionals in the municipal securities field.
Municipal Bond Price or Basis Quotations
Municipal bonds are usually priced and offered for sale on a yield to maturity (YTM) basis rather than a dollar price. This is called a basis quote. The bond's basis is its YTM. If the bond is quoted at 3.78 basis, it means the YTM is 3.78% Each basis point is 1/100 of 1 percent. One point on a bond is equal to $10 and 1 basis point is $0.10 Test Topic Alert* If a question mentions a 6% bond quoted on a 6.5 basis, you should be able to determine the coupon of the bond is 6% and its YTM is 6.5%.
Analyzing the Official Statement (OS)
Municipal bonds provide a form of prospectus, (disclosure document), known as an official statement. Analysts study the documents included in the OS to determine the issuer's financial condition at the present and in the forseeable future.
Conflicts of Interest
Potential "conflicts of interest" arise if a firm acts as both underwriter and financial advisor for the same issue. The MSRB has the following requirements. The MSRB simply prohibits a broker/dealer that serves as a financial advisor to a municipal issuer for any issue sold on either a negotiated or competitive bid basis from switching roles and underwriting the same issue. In other words, if a broker/dealer is acting as a financial advisor to the issuer, generally they may not participate in underwriting the bonds of the issuing municipality. However, there are some allowable exceptions. For example, a broker/dealer that has a financial advisory relationship with an issuer with respect to the issuance of municipal securities will still be permitted to assist with preparing the official statement and other similar duties normally associated with underwriting. They can also purchase the bonds from an underwriter either for their own trading account or for the accounts of their customers. But in all cases, if performing such functions or acting in such a capacity as described above, the broker/dealer may not receive any compensation other than for financial advisory services to the issuer. In other words, no underwriting compensation can be received by the broker/dealer who is acting in an advisory capacity. Customers who might be purchasing new securities from a broker/dealer that is acting in an advisory capacity to a municipality must be informed that the advisory relationship exists at or before confirmation of the sale.
Applications of Revenues
Principal and interest on revenue bonds are paid exclusively from money generated by the facility the issuer finances. The issuer pledges to pay expenses in a specific order, called the flow of funds. In most cases, a net revenue pledge is used, meaning that operating and maintenance expenses are paid first. The remaining funds (or net revenues) are used to pay debt service and meet other obligations.
Legal Opinion
Printed on the face of every bond certificate is a legal opinion written and signed by the BOND COUNSEL, an attorney specializing in tax-exempt bond offerings. The ISSUER OF THE DEBT is responsible for retaining the bond counsel. The legal opinion states that the issue is legally binding on the issuer and conforms to applicable laws. If interest from the bond is tax-exempt, that too is stated in the legal opinion. The legal opinion is issued either as a QUALIFIED OPINION (there may be a legal uncertainty of which purchasers should be informed) or as an UNQUALIFIED OPINION (issued by the bond counsel unconditionally). Some issuers, usually smaller municipalities, choose not to obtain a legal opinion. In such a case, the bond certificate must clearly state that the bonds are ex-legal. The ex-legal designation allows a bond to meet good delivery requirements without an attached legal opinion.
Record keeping for Municipal Securities Firms
Records of Associated Persons (RULE G-7) A muni securities dealer must obtain and keep on file specific information about its associated persons. The MSRB defines an associated person as anyone with a securities registration. That would include reps and principals, but not clerical help. Most of the required info (employment history, disciplinary history, residence and personal data) is contained on the U4 and U5 forms. Any material change must be updated within 30 days. These records must be kept for a MINIMUM OF 3 years after the termination of the associated person.
Refunding
Refunding is like refinancing a loan, such as a mortgage. When interest rates fall, the muni issues a new bond (at lower rates). Then they use the proceeds from the new bond to pay off the old, higher interest debt. There are two types of refunding. -Advance refunding (Prerefunding) -Current Refunding
Sources of Revenue
Revenue Bonds' interest and principal payments are payable to bondholders only from the specific earnings and net lease payments of revenue-producing facilities such as: -utilities -housing -transportation -education -health -industrial -sports Debt service programs do not come from general or real estate taxes and are not backed by the municipality's full faith and credit. Revenue bonds are considered self-supporting debt because principal and interest payments are made exclusively from revenues generated by the project for which the debt was issued.
Revenue Bond Analysis
Revenue bonds are rated according to a facility's potential to generate sufficient money to cover operating expenses and principal and interest payments. Revenue bonds are not repaid from taxes, so they are not subject to statutory debt limits. Revenue bonds are meant to be self-supporting, and if the facility they finance does not make enough money to repay the debts, the bondholders, not the tax payers, bear the risk. When assessing the quality of revenue bonds, an investor should consider the following factors: -Economic justification: the facility being built should be able to generate revenues -Competing facilities: a facility should not be placed where better alternatives are easily available -Sources of Revenue: The sources should be dependable -Call provisions: with callable bonds, the higher the call premium, the more attractive a bond is to an investor -Flow of Funds: Revenues generated must be sufficient to pay all of the facilities operating expenses and to meet debt service obligation.
Revenue Bonds
Revenue bonds can be used to finance any municipal facility that generates sufficient income. Revenue Bonds are not subject to statutory debt limits and do not require voter approval. A particular revenue bond issue, however, may be subject to an additional bonds test before subsequent bond issues with equal liens on the project's revenue may be issued. The additional bonds test ensures the adequacy of the revenue stream to pay both the old and new debt.
Books and Recordkeeping Requirements (Rule G-9 and G-9)
Rule G-8 lists the various records to be made and Rule G-9 states the retention requirements. Record maintenance requirements specify the length of time that various records must be kept. Generally, records are categorized into the following three maintenance periods: -Records kept for the lifetime of the firm -Records kept for 6 years -Records kept for 4 years Lifetime Records: -Articles of incorporation/partnership agreement -Minutes of board or partnership meetings -Records of stock certificates 6 year Records: -Blotters (records of original entry) -General Ledger (accounting information such as income and expense and assets and liabilities -Customer ledgers (statements of the customer's accounts) -Customer account records(6 years after the account is closed) -Customer complains (only written complaints are considered and email is written) -Principal designation record (which individual supervises what) TTA*** MSRB rules list customer complaints as 6 year record. FINRA rules only require a 4 year period. THIS DIFFERENCE IS LIKELY TO BE TESTED TAKE NOTE** MSRB Rule G-9 requires that designations of principals must be maintained for 6 years. All records must be kept READILY AVAILABLE for 2 years.
Special Assessment Bonds (Special district bonds)
Special Assessment bonds are issued to finance the construction of public improvements such as streets, sidewalks, or sewers. The issuer assesses a tax only on the property that benefits from the improvement and uses the funds to pay principal and interest.
Special Tax Bonds
Special Tax Bonds are bonds by one or more designated taxes other than ad valorem (property) taxes. For example, bonds for a particular purpose might be supported by sales, tobacco, alcohol, fuel, or business license taxes. However, the designated tax does not have to be directly related to the project purpose. Such bonds are not considered self-supporting debt. That means that other sources may be used if the taxes generated are insufficient. You might see these called designated tax bonds.
Local Government Investment Pools (LGIPs)
States establish LGIPs to provide other government entities, such as cities, counties, school district, or other state agencies, with a short term investment investment funds. The LGIPs are generally formed as a trust in which municipalities can purchase shares or units in the LGIPs investment portfolio. While not a money market fund, most LGIPs operate similar to one. For instance, an LGIP may be permitted to maintain a fixed $1 net asset value. Maintaining a stable NAV, similar to a money market MF, facilitates liquidity and minimum price volatility. LGIPs are not required to register with the SEC and are not subject to the SECs regulatory requirements, given that LGIPs fall within the governmental exemption, just as muni securities do. Therefore, investment guidellines and oversignt for LGIPs can vary from state to state. With no SEC oversight, there is no prospectus. However, LGIP programs do have disclosure documents, which generally include information statements, and investment policy and operating procedures. The information statement typically details the management fees associated with participation in the LGIP.
Net Revenue Pledges continued...
TTA** If you see questions that require differentiating gross revenue and net revenue pledges, maybe this will help: the name of the pledge tells you how debt service is paid. In a gross revenue pledge, debt service is paid first, from gross revenues. Operations and maintenance expenses are paid after debt service. In a net revenue pledge, debt service is paid from the net revenues, meaning operations and maintenance costs are paid first. This is the more common of the two pledges.
The Debt Statement
The Debt Statement is used in the analysis of GO debt. It includes the estimated full valuation of taxable property, estimated assessed value of property, and the assessment percentage. To evaluate the muni's debt structure, an analyst calculates TOTAL DEBT, the sum of all bonds issued by the muni, and subtracts SELF-SUPPORTING DEBT from this figure. Although revenue bond debt is included in total debt, it is backed by revenues from the facility it financed and is not a burden on the muni's taxpayers. The result is the Muni's NET DIRECT DEBT, which includes GOs and short-term notes issued in anticipation of taxes or for interim financing. Overlapping debt disclosed on the debt statement is the city's proportionate share of the debts of the county, school district, park district, and sanitary district. The city's NET TOTAL DEBT, also called NET OVERALL DEBT, is the sum of the overlapping debt and the net direct debt.
Municipal Bond Marketability Factors
The MSRB defines marketability as, "the ease or difficulty with which securities can be sold in the market. A muni security's marketability depends upon many factors, including its coupon, yield, dollar price, security provisions, maturity, credit quality, and rating, if any. In the case of a new issue, marketability also depends on the size of the issue, the timing of its issuance and the volume of comparable issues being sold.
Variable Rate Demand Obligations (VRDOs)
The MSRB defines variable rate demand obligations as floating rate obligations that typically have a nominal long-term maturity of 20-30 years, but have an interest rate that is reset periodically. The reset can be daily, weekly, monthly, semiannually, or flexible. Matching the interest rate to market conditions tends to keep the price of these relatively stable. One of the key features of this security is the ability of the investor to demand the issuer repurchase the bods at par value. This can be done on any reset date. In essence, this is a put option where the investor "puts" the bond and receives the face amount plus any accrued interest. This feature is why VDROs are sometimes considered money market instruments. In fact, you can find them in the portfolio of many money market mutual funds.
Rule Enforcement
The MSRB has no authority to enforce the rules it makes. While the SEC oversees all securities- related rule enforcement, the MSRB rules concerning muni securities dealers are specifically enforced by FINRA. Much of the muni securities business is done by dealer banks. These are commercial banks that are not members of FINRA or any exchange. For those market participants, enforcement is in the hands of various banking agencies. -The Office of the Comptroller of the Curreny -The Federal Reserve Board -The Federal Deposit Insurance Corporation (FDIC)
Statutory Debt Limits
The amount of debt that a municipal government may incur can be limited by state or local statues to protect taxpayers from excessive taxes. Debt limits can also make a bond safer for investors. The lower the debt limit, the less risk of excessive borrowing and default by the municipality. If a municipality wishes to issue GOs that would put it above its statutory limit, a public referendum is required. Voter approval on the referendum must follow. -Tax Limits: Some states limit property taxes to a certain percentage of the assessed property value or to a certain percentage increase in any single year. The tax rate is expressed in mills; on mill equals $1 per $1,000 or $0.001 -Limited Tax GOs: A limited tax GO bond is a bond secured by a specific tax. Alternatively, the limit is placed on the amount of tax that may be assessed as just described. In other words, the issuer is limited as to what tax or taxes or how much can be used to service the debt. As a result, there is more risk with limited tax GOs than with a comparable GO backed by the full taxing authority of the issuer. -Overlapping Debt: Several taxing authorities that draw from the same taxpayers can issue debt. Bonds issued by different municipal authorities that tap the same taxpayer wallets are known as COTERMINOUS DEBT TTA** In the context of municipal securities, the term COTERMINOUS refers to two or more taxing agencies that share the same geographic boundaries and are able to issue debt separately. Overlapping debt occurs when two or more issuers are taxing the same property to service their respective debt. Take Note** Coterminous debt only occurs in property taxing situations. Because states do not generally tax real estate, STATE DEBT NEVER OVERLAPS.
Accrued Interest and the Dated Date
The dated date is the date from which interest accrual begins for new bond issues. Even if a bond is issued at a later date, the bond starts accruing interest on the date designated as the dated date. For example, if the bond's dated date is April 1 and the interest payment dates are June 1 and Dec 1, the first interest payment will be on Dec 1 and will be for 8 months of interest.
Protective covenants
The face of a revenue bond certificate may refer to a trust indenture. This empowers the trustee to act on behalf of the bondholders. In the trust indenture, the municipality agrees to abide by certain protective covenants, or promises, meant to protect bondholders. A trustee appointed in the indenture supervises the issuer's compliance with the bond covenants.
Rating
The higher the rating, the more marketable the bond. Many large institutional investors, such as banks and insurance companies, are generally limited to investment-grade debt. In some cases, they are limited to the top two grades (AA or Aa). As the number of potential investors increases, so does the marketability.
The Underwriter's Counsel
The managing underwriter may choose to employ another law firm as underwriter's counsel. This firm is not responsible for the legal opinion and is employed and is employed to represent the underwriter's interests. Take Note**: Issuers desire an unqualified legal opinion The issuer retains the bond attorneys, or the bond counsel, for a new municipal bond issue. The underwriters may also hire bond counsel, but they do not provide the legal opinion.
Future Financial Needs
The muni's financial statements should be scrutinized for signs of future debt requirements. The Muni might need to issue more debt if -its annual income is not sufficient to make the payments on its short-term (or floating) debt -principal repayments are scheduled too close together -sinking funds for outstanding term bonds are inadequate, -pension liabilities are unfunded -it plans to make more capital improvements soon Issuing more debt in the near future could damage an issuer's credit rating, which would cause the current issue to trade at a lower price.
Muni Bonds purchased at a Premium
The purchaser of a muni bond at a premium must amortize the premium on a straight line basis over the remaining life of the bond. It makes no difference if the bond was purchased as a new issue or in the secondary market. Straight-line amortization means that an equal amount of the premium will be amortized each year the bond is held. Example: A customer buys an 8% muni bond with eight YTM at a price of $108. The premium of eight points ($80) must be amortized over the remaining eight YTM. The annual amortization amount is one point, or $10 per bond. After one year, the cost basis is 107; after 2 years its 106, and so on. If held to maturity, there is no capital loss because the cost basis at that time has been reduced to par. AMORTIZATION: -reduces cost basis -reduces reported interest income In the example, cost basis is reduced each year by $10 per bond. In addition, interest income of $80 per bond is reduced to $70 per bond (the amount of the annual amortization). B/c interest income on muni bonds is not taxed, its annual amortization has no tax effect. If the bond is sold before maturity, gain or loss is the difference between sale price and adjusted cost basis. Take the following example. A customer buys a 5 year muni bond at 105. 2 years later, the bond is sold at 104. What is the customer's gain or loss? The premium of 5 points must be amortized over a 5 year period, so the annual amortization is one point, or $10 per bond. After 2 years, the bond's cost basis is 103 so a sale at 104 creates a one-point capital gain per bond.
Trust Indenture
The trust indenture's provisions may vary, but a number of standard provisions are common to most bond issues, including the following: RATE COVENANT: a promise to maintain rates sufficient to pay expenses and debt service. MAINTENANCE COVENANT: A promise to maintain the equipment and facility/facilities INSURANCE COVENANT: A promise to insure any facility built so bondholders can be paid off if the facility is destroyed or becomes inoperable. ADDITIONAL BONDS TEST: Whether the indenture is OPEN-ended(allowing further issuance of bonds with the same status and equal claims on assets or revenues if permitted under the provisions of the bond indenture) or closed-ended (allowing no further issuance); with a closed-end provision, any additional bonds issued will be subordinated to the original issue unless the funds are specifically required to complete construction of the facility. SINKING FUND: Money to pay off interest and principal obligations. CATASTROPHE CLAUSE: A promise to use insurance proceeds to call bonds and repay bondholders if a facility is destroyed; a catastrophe call is also called a calamity call or an extraordinary mandatory call. Bonds with a catastrophe call are not designated callable bonds on the trade confirmation. FLOW OF FUNDS: The priority of disbursing the revenues collected. BOOKS AND RECORDS COVENANT: Requires outside audit of records and financial reports. CALL FEATURES: call dates and call prices. Take Note: Trust Indentures are not required for municipal bonds per the TRUST INDENTURE ACT OF 1939. Municipal issues are exempt from this act. The use of trust indentures is optional, but it greatly enhances the marketability of revenue issues. Revenue bonds have either a trust resolution or trust indentures, whereas GOs commonly have a bond resolution.
Variable Rate Municipal Securities
These are municipal debt securities with interest rates that fluctuate based on current market interest rate changes. The MSRB calls these RESET SECURITIES because the interest rate is reset at certain intervals. The exam may ask you about 2 types of variable rate securities -Variable Rate Demand Obligations (VRDOs) -Auction Rate Securities (ARS)
Tax Credit BABS
These types of BABs provide the bondholder with a federal income tax credit equal to 35% of the interest paid on the bond in each tax year. If the bondholder lacks sufficient tax liability to fully use that year's credit, the excess credit may be carried forward.
Current Refunding
This differs from advance refunding in that the old bonds will be redeemed within 90 days or less from the date of issuance of the refunding bonds. In either case, refunding increases the quality of the bonds. This leads to greater marketability.
Advance Refunding (prerefunding)
This is refinancing an existing muni bond issue before its maturity or call date by using money from the sale of a new bond issue. The proceeds of the new bond issue are used to purchase special government securities. To comply with the complex restrictions imposed by the IRS, the muni places the proceeds of a muni pre-refunding in an escrow account that immediately invests in state and local government securities series. These are US Government securities issued directly by the Treasury TO MUNI ISSUERS ONLY in connection with prerefuding. They are usually referred to by the acronym SLGS and pronounced "slugs". The muni then uses these funds to pay off the original bond issue at the first call date.
Rule G-37 Political Contributions
This rule prohibits muni firms from engaging in muni securities business with an issuer for two years after any political contribution is made to an official of that issuer. In this context, muni securities business refers to negotiated underwritings, not to competitive underwritings. The idea is to prevent firms from making large political contributions in return for being selected as underwriter for that issuer. The rule applies to contributions by the firm, its MFPs, and by political action committees controlled by the firm or its representatives. De minimis contributions of up to $250 per election are permitted by MFPs, as long as these individuals are eligible to vote for the issuer official. This exemption does not apply to firms.
Trading Flat
When a debt security is trading flat, it means no accrued interest is included in the transaction. In most cases, this occurs when the issuer is in default of interest payments. Of course, this is also the case with zero coupon bonds b/c there is no interest being paid. All bonds paying semiannual interest trade flat twice each year. When the trade takes place so that it settles on an interest payment date, there is no accrued interest b/c the seller will receive a check from the issuer for the interest. We like that to the broken clock that shows the correct time twice a day.
Use of ownership information
While acting in a fiduciary capacity for an issuer, a municipal securities dealer often obtains confidential information about its bondholders. The dealer cannot use this information to solicit purchases or sales of municipal securities or to pursue other financial gain without the issuer's consent. Examples of fiduciary capacities include, but are not limited to, acting as a paying agent, transfer agent, registrar, or indenture trustee for an issuer.
Other types of Quotations
Workable Indication: reflects a bid price at which a dealer will purchase securities from another dealer. A dealer giving a workable indication is always free to revise the bid for the securities as market conditions change. Nominal, or subject, quotation: Indicates a dealer's estimate of a security's market value. Nominal quotations are provided for informational purposes only and are permitted if the quotes are clearly labeled as such. The rules on nominal quotes apply to all municipal bond quotes distributed or published by any dealer. Holding a quote: A municipal securities dealer may quote a bond price that is firm for a certain time. This is called an "OUT-FIRM" with recall quote. These quotes are firm for an hour with a five-minute recall period. This provides time for the dealer who requested the quote to search for a better quote before selling the bond. If the firm that made the quote has another buyer interested in the same bonds, that firm can contact the dealer and give them five minutes to act on the quote. If no action is taken and a transaction does not take place within the five-minute recall period, then the dealer loses the right to buy the bonds at the quoted price. Take NOTE* Receiving an out-firm quote allows dealers to try to sell bonds that they don't own, knowing that if they find a buyer within the allotted time, they can buy the bonds at a fixed price from the firm providing the out-firm quote.
