2D Municipal Debt
Which of the following municipal issues is a short term note that is retired by a later permanent bond sale? A. BAN B. RAN C. TAN D. TRAN
A. Municipalities issue BANs (Bond Anticipation Notes) to "pull forward" funds that will be collected from a later permanent bond sale. For example, a municipality expects to float a 20 year bond issue in 6 months. It can get the funds today by issuing 6 month BANs now. When the bond issue is floated, the proceeds are used to pay off the BANs. Municipalities issue TANs (Tax Anticipation Notes) to "pull forward" funds that will be collected as taxes in later months. For example, if taxes are due on April 15th, and it is now January 15th, and the municipality wishes to get funds at this time, it can issue 3 month TANs. When the taxes are actually collected, the proceeds are used to retire the TAN issue. RANs (Revenue Anticipation Notes) are issued to "pull forward" revenues that are expected to be received by the municipality in the coming months. For example, the City of New York will receive a $200,000,000 payment from the Federal government on July 1st to support mass transit. It is now April 1st. The city can issue 3-month RANs and borrow against the upcoming revenue to be received from the Federal Government. A TRAN is a combination Tax and Revenue Anticipation Note.
A promise by a municipality to call in a bond issue if the facility built with the proceeds of the offering is condemned, is a: A. calamity call covenant B. rate covenant C. maintenance covenant D. insurance covenant
A. A calamity call covenant is a type of optional mandatory call provision that obligates an issuer to call in the bonds if the facility is destroyed by some catastrophic event. Since the facility would be insured, the insurance monies are used pay for the retirement of the bonds.
A "qualified" legal opinion is one which: A. gives a conditional affirmation of the legality of the securities B. gives an unconditional affirmation of the legality of the securities C. is given by a qualified bond counsel D. qualifies the issue for a federal tax exemption from taxation
A. A qualified legal opinion is one where the bond counsel has found a legal or tax "problem", and the counsel details the "qualification" in the opinion. Thus, the opinion is a conditional affirmation of the legality of the issue.
New issues of municipal short term notes are available in which form? A. Book entry B. Bearer C. Fully registered D. Registered to principal and interest
A. All new debt issues only come in book entry form.
All of the following callable municipal bonds are trading at a 5% basis. Which is LEAST likely to be called? A. 3 3/4% coupon rate callable at 103 in 2016 B. 4 1/2% coupon rate callable at 103 in 2016 C. 5% coupon rate callable at 100 in 2016 D. 6 3/4% coupon rate callable at 100 in 2016
A. An issuer is least likely to call bonds which have low interest rates (low financing cost to the issuer) and high call premiums (expensive for the issuer to call in these bonds).
Credit analysis of an airport authority revenue bond would include evaluation of all of the following EXCEPT: A. Overlapping debt B. Competing facilities C. Flow of funds D. Debt coverage ratios
A. Credit analysis of a revenue bond issue will include the impact of competing facilities; analysis of the flow of funds (e.g., is it a gross revenue pledge or a net revenue pledge?); and computation of the coverage ratios (Funds Available for Debt Service/Annual Debt Service Requirements). Overlapping debt is not relevant to revenue bond analysis - each revenue bond is self supporting. Overlapping debt is considered in a General Obligation bond analysis.
Which of the following revenue bond issues would likely pledge the earnings from invested endowment funds to the bondholders? A. Hospital bond B. Water and Sewer bond C. Mortgage bond D. Turnpike bond
A. Hospitals and colleges are often given large monetary gifts - known as "endowments." The institution invests the endowment funds to generate interest and dividend income. It usually agrees not to invade the principal amount. The earnings on the endowment funds are a source of revenue that can be pledged to bondholders under a revenue pledge.
Which of the following actions must be taken if a municipality wishes to raise its debt limit? A. Public referendum B. Court order C. Judicial edict D. Tax assessmen
A. If a municipality wishes to raise its debt limit, the voters must approve via a public referendum. In effect, the voters are approving an increase in their taxes when they approve such a measure.
A bond contract contains the following information: Issue Date: July 1, 2006 First Call Date: July 1, 2016 Date of Call Price 2016 105 2017 104 2018 103 2019 102 2020 and after100 If the issuer calls the bonds at 104 in the year 2016, the issuer is making a(n): A. optional call B. extraordinary optional call C. mandatory call D. extraordinary mandatory call
A. In the bond contract, the issuer may have the right to call in the entire issue at preset dates and prices (a normal call schedule, usually with at least 10 years of call protection given to the bondholder). The issuer has the option of calling in the bonds at those dates and prices; and will only do so if it is advantageous to the issuer (meaning that interest rates have dropped since the bonds were issued).
Industrial development bonds are issued by municipalities to build facilities that are leased to: A. corporations B. government agencies C. municipalities D. sovereign governments
A. Industrial development bonds are issued by municipalities to build facilities that are leased to corporations. These are a type of revenue bond where the lease payments made by the corporate lessee are the source of funds to pay debt service on the issue.
Which of the ratings agencies listed below would most likely rate a municipal hospital revenue bond issue for credit risk? A. Moody's B. Morningstar C. Fitch's D. Best's
A. Moody's and Standard and Poor's are, by far, the largest of the ratings firms. Both rate municipal revenue bonds. Standard and Poor's rates issues if the issuer pays; Moody's rates issues whether the issuer pays or not - their stance is that they are Moody's Investors Services, and their ratings are a service to the investor (though paid for by the issuer). Fitch's is a much smaller ratings agency and concerns itself mainly with rating corporate issues. Morningstar rates mutual funds, not municipal bonds. Best's rates insurance companies, not securities.
A municipality has a tax rate of 9 mills. A piece of real property in the municipality is assessed at $150,000 and has a fair market value of $155,000. The annual tax liability on the property is: A. $1,350 B. $1,395 C. $13,350 D. $13,950
A. One mill = .001; 9 mills = .009. Taxes are based on assessed valuation, not fair market value. .009 x $150,000 = $1,350. Another way to think about it is that 1 mill = $1 of tax for each $1,000 of assessed value.
The Bond Resolution is the contract between the: A. issuer and bondholder B. bond counsel and issuer C. bond counsel and bondholder D. issuer and Municipal Securities Rulemaking Board
A. The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions.
The interest income received from older Industrial Revenue bonds may be taxable to the holder at regular income tax rates if the holder: A. is a "substantial user" of the facility built with the proceeds of the issue B. receives more than $10,000 per year in interest income from the bonds C. has purchased the bonds in a margin account and has borrowed against the position D. is an officer of the issuer
A. The interest income earned from Industrial revenue bond issues that were issued prior to 1986 was generally tax exempt. The Tax Reform Act of 1986 made this "private use" interest income taxable. An issue arises regarding older "tax free" industrial revenue bond issues. Essentially, the lease payments made by the corporation are used to fund the interest payments made on the outstanding debt. These lease payments are tax deductible to the corporate lessee. If the corporation were to buy the outstanding bond issue, it would receive interest payments on the bonds that are tax free. Effectively, the corporation has taken a tax deduction for the lease payments; and has converted these payments into tax free interest income. The IRS does not allow this. If the purchaser of the bonds is a "substantial user" of the facility being leased, then the interest income received becomes taxable to the corporate lessee. This is only fair, since the lease payments used to fund the payment of that interest income were tax deductible to the corporation.
The ratio of net direct debt plus overlapping debt to assessed valuation is used for all of the following EXCEPT to: A. evaluate the issuer's ability to collect taxes owed B. evaluate the issuer's overall ability to service its debt burden C. analyze general obligation bonds D. evaluate the issuer's creditworthiness
A. The ratio of net direct debt plus overlapping debt to assessed valuation is used to evaluate general obligation bonds (which are typically paid by ad valorem taxes collected based upon property assessments). The lower the ratio, the better the creditworthiness of the issuer and the better able the issuer is to handle servicing the debt. However, the ratio does not indicate how good a job the municipality does collecting the taxes due. This is measured by the collection ratio - the ratio of taxes collected to taxes assessed.
A hospital has been financed through a revenue bond issue containing a Net Revenue Pledge. Prior to paying Debt Service, all of the following expenses would be deducted by the issuer EXCEPT: A. Depreciation and amortization B. Garbage disposal costs C. Wages D. General expenses
A. Under a Net Revenue Pledge, operation and maintenance is funded before Debt Service is paid. This is accounted for on a cash basis. Thus, operating costs such as garbage disposal transport, wages, and general and administrative costs are funded before monies go to pay Debt Service. Depreciation and amortization are non-cash expenses and are not counted.
Variable rate municipal notes avoid which of the following risks? A. market risk B. default risk C. marketability risk D. credit risk
A. Variable rate municipal notes avoid "interest rate risk," also known as market risk, since a rise in interest rates will not devalue these securities. With a fixed rate note, as interest rates rise or fall, the note's value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes is adjusted up or down, based upon prevailing market interest rates; thus the price of the instrument will stay at, or very close to, par.
To smooth out tax collections, a municipality will issue a? A. BAN B. TAN C. RAN D. TRAN
B. Municipalities issue TANs (Tax Anticipation Notes) to "pull forward" funds that will be collected as taxes in later months. For example, if taxes are due on April 15th, and it is now January 15th, and the municipality wishes to get funds at this time, it can issue 3 month TANs. When the taxes are actually collected, the proceeds are used to retire the TAN issue. RANs (Revenue Anticipation Notes) are issued to "pull forward" revenues that are expected to be received by the municipality in the coming months. For example, the City of New York will receive a $200,000,000 payment from the Federal government on July 1st to support mass transit. It is now April 1st. The city can issue 3-month RANs and borrow against the upcoming revenue to be received from the Federal Government. A TRAN is a combination Tax and Revenue Anticipation Note. A BAN is a Bond Anticipation Note - a short term note that will be retired by a later long term bond sale.
A "calamity call" is a(n): A. mandatory call B. extraordinary mandatory call C. optional call D. extraordinary optional call
B. A calamity call obligates an issuer to call in the bonds, returning the borrowed monies to the bondholders, if a catastrophic event occurs that destroys a facility that is the revenue source backing the issue. This is an "extraordinary event" and it is mandatory that the bonds be called.
In a municipal bond contract, a "covenant of defeasance" would allow the issuer to: A. redeem the issue in part or full at predetermined date(s) and prices B. advance refund the issue under the terms specified in the bond contract C. omit interest or principal repayments if coverage ratios decline below specified limits D. reset interest rates periodically at predetermined dates based upon recognized interest rate indices
B. A municipal "covenant of defeasance" allows the issuer to "advance refund" the bond issue under the terms specified in the bond contract. An issuer will take advantage of this covenant if interest rates have dropped and the issue is not currently callable. To advance refund the issue, the issuer buys enough U.S. Government securities to meet the debt service requirements on the issue and places then in escrow with a trustee. The maturity on the U.S. Governments matches the maturity (or first call date) of the outstanding bonds. The interest payments received from the U.S. Governments are used to meet the debt service requirements. When the U.S. Governments mature, the proceeds are used to retire the issuer's debt. By advance refunding, the issuer removes the existing debt as its own liability, freeing it to issue new debt at lower current interest rates.
Income sources backing a special tax bond issue could be all of the following EXCEPT a(n): A. gasoline tax B. property tax C. sales tax D. alcohol tax
B. Ad valorem (property) taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales and income taxes).
A municipal revenue bond trust indenture includes an "additional bonds test" covenant. This means that: A. the issuer is prohibited from issuing new debt under any circumstance B. the issuer is prohibited from issuing new debt unless the facility's revenues are sufficient to pay for existing and additional debt C. the issuer is prohibited from issuing new debt unless outstanding bonds are called D. additional debt can be issued without restriction
B. An "additional bonds test" means that the issuer is prohibited from issuing new bonds against the revenues of a facility, unless the facility's revenues are sufficient. Typically, the debt service on the old bonds is added to that of the new bonds. The revenues of the facility must cover, by an adequate margin, the combined debt service before additional bonds can be sold.
Which statement is TRUE about a Certificate of Participation (COP)? A. COPs are subject to statutory debt limits B. COPs are backed by a pledge of lease revenues C. COPs have a higher credit rating than G.O. bonds of the same issuer D. COPs are full faith and credit obligations of the issuer
B. As municipalities reached their debt limits with G.O. bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states. A COP is issued by a state entity where lease revenues are pledged to back the issue. The lease payments are received from a project such as a university dormitory, prison, municipal office building, municipal transit system, etc. The "difference" is that the lease payment is made based on the governing body making an annual appropriation from tax collections, and it is not "legally" obligated to do so, hence it is not really a bond. Rather, it is a security that gives the holder a share of "revenue" if the appropriation is made (which it will be, otherwise that issuer's credit rating would be trashed). COP issuance has increased greatly over the years because they are easier to issue than G.O. debt (no pesky debt limits or voter approval to deal with) - but they are sold at a slightly higher yield, because they have more credit risk.
All of the following statements are true about "Build America Bonds" EXCEPT: A. the issuer gets a federal tax credit equal to 35% of the stated interest rate on the issue B. the interest is federally tax exempt C. the bonds give municipal issuers access to the conventional corporate debt market D. the proceeds of the bond issues can only be used for infrastructure improvements
B. Build America Bonds (BABs) were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the broader corporate debt market (which includes international investors who do not participate in the municipal market) for needed capital projects.
Which of the following would NOT be considered when evaluating the credit risk of a municipal revenue bond? A. Coverage ratios B. Legislative actions C. Competing facilities D. Management experience
B. Credit risk is the risk that a bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Legislative actions have no bearing on credit risk. Potential effects of adverse legislative actions would be evaluated as legislative risk.
All of the following are sources of income available for general obligation bond debt service EXCEPT: A. ad valorem taxes B. highway tolls C. license fees D. assessments
B. General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues. Highway tolls are pledged to pay the debt service on revenue bonds that are sold to finance the construction of the road. These monies are not available to pay the debt service on G.O. bond issues.
A municipality is at its statutory debt limit and cannot legally issue more debt backed by taxing power. Which of the following bonds can be issued? A. General obligation bonds B. Moral obligation bonds C. Double barreled bonds D. Treasury bonds
B. If a municipality is at its debt limit, it cannot issue more debt backed by ad valorem taxing power - thus it cannot issue more G.O. bonds; nor can it issue double barreled bonds (the second backing of these issues is ad valorem taxing power). The municipality can issue moral obligation bonds. Moral obligation bonds are backed by pledged revenues and also by a non-binding pledge to report any revenue deficiencies to the state legislature. The legislature is authorized to apportion the funds necessary to service the debt, but is under no obligation to do so. Municipalities do not issue Treasury Bonds - these are issued by the U.S. Government.
A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive: A. $500 B. 103% of $500 C. $1,000 D. 103% of $1,000
B. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.
A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive: A. $500 B. $515 C. $1,000 D. $1,030
B. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract. 103% of $500 = $515.
A municipal issuer would call an issue for all of the following reasons EXCEPT: A. substantial funds have accumulated in the issuer's surplus account B. interest rates have risen sharply since the issuance of the bonds C. the facility built with the proceeds of the issue has been destroyed in a flood D. the proceeds of the issue were never expended due to legal obstacles
B. If substantial funds have accumulated in the surplus account, the issuer would use the monies to retire debt and reduce the annual interest cost. If a facility is destroyed by a flood, a catastrophe call covenant would be activated, requiring the issuer to call in the bonds. This is done since the facility can no longer generate the revenues to service the debt. If a bond issue is floated and the monies collected are never used for their intended purpose, most bond contracts require that the issuer refund the money to the bondholders. This would be accomplished by calling in the bonds. An issuer would only call in bonds when interest rates have fallen, since the debt could be replaced with lower interest rate financing. An issuer would never refund its debt if interest rates have risen. (Would you go out and refinance your mortgage at a higher interest rate?)
Who guarantees an Industrial Development Bond? A. Municipal issuing authority B. Corporate lessee C. MBIA D. AMBAC
B. Industrial Development Bonds are issued by municipal authorities, with the revenue source being the lease payments made by a corporate lessee. Furthermore, the corporate lessee unconditionally guarantees the bonds - so they take on the credit rating of the corporate guarantor.
Mandatory redemption provisions can only be met by: A. advance-refunding the issue B. depositing the required funds to the sinking fund C. pre-refunding the issue D. making a tender offer for the outstanding bonds
B. Mandatory redemption provisions can only be met by depositing the required funds to the sinking fund. Once these monies are deposited, the issuer must use them to retire bonds as specified in the bond contract. The bonds may be retired by calling in bonds or by purchasing bonds in the open market.
Municipalities would issue tax exempt commercial paper for all of the following reasons EXCEPT to: A. meet a temporary cash shortage due to unforeseen extraordinary expenses B. refund an outstanding bond issue C. provide construction period financing that will be permanently financed by a future bond sale D. smooth out collections of funds that are normally subject to seasonal fluctuations
B. Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a bond anticipation note). Commercial paper cannot be used for long term financing such as a bond refunding.
Net Overall Debt of a municipality is: A. Bonded Debt + Overlapping Debt B. Net Direct Debt + Overlapping Debt C. Bonded Debt - Overlapping Debt D. Net Direct Debt - Overlapping Debt
B. Net Overall Debt of a municipality is used as the numerator in Debt Per Capita and Debt to Assessed Value ratios. These ratios measure the relative size of the municipality's debt level. Net Overall Debt is: Net Direct Debt + Overlapping Debt.
The ratio that shows how well the municipality manages its cash receipts is the: A. debt per capita ratio B. collection ratio C. pledged revenue to debt service requirements ratio D. debt to assessed valuation ratio
B. The collection ratio of a municipality is: Collection Ratio = Taxes Collected/Taxes Assessed One looks for a very high ratio (better than 95%), meaning that the municipality is truly collecting the taxes it is assessing.
The interest income received from older Industrial revenue bonds may be taxable to the holder at regular income tax rates if the holder is: A. not an "equal opportunity employer" B. the "substantial user" of the facility built with the proceeds of the issue C. subject to "statutory disqualification" as defined under the Securities Exchange Act of 1934 D. considered to be an "insider" of the corporate lessee
B. The interest income earned from Industrial revenue bond issues that were issued prior to 1986 was generally tax exempt. The Tax Reform Act of 1986 made this "private use" interest income taxable. An issue arises regarding older "tax free" industrial revenue bond issues. Essentially, the lease payments made by the corporation are used to fund the interest payments made on the outstanding debt. These lease payments are tax deductible to the corporate lessee. If the corporation were to buy the outstanding bond issue, it would receive interest payments on the bonds that are tax free. Effectively, the corporation has taken a tax deduction for the lease payments; and has converted these payments into tax free interest income.
The ratio of pledged revenues to debt service requirements would be used to analyze which of the following municipal issues? A. School District Bonds B. Hospital Revenue Bonds C. Special Tax Bonds D. General Obligation Bonds
B. The ratio of pledged revenues to debt service requirements applies to revenue bonds. Pledged revenues are those pledged to pay debt service and any other requirements set in the bond contract. The bondholder has a lien on these revenues. The higher this ratio, the safer a revenue bond, since there is a greater ratio of revenues to cover debt service. School district bonds are G.O. issues, paid by unlimited ad valorem taxing power; applicable ratio tests would be debt per capita (How much debt is each citizen of the town responsible for?); debt to assessed valuation (How much debt is there outstanding against the real properties that are assessed taxes to pay for the interest expense on that debt?); and the collection ratio (Of the taxes assessed by the municipality, what percentage is actually collected?)
Under the flow of funds in a revenue bond trust indenture, the first use of NET revenues is to pay: A. operation and maintenance B. debt service C. debt service reserve D. reserve maintenance fund
B. This is tricky! Net revenues are defined as gross revenues less operation and maintenance costs. Once operation and maintenance are covered, the net revenues that remain are first used to pay debt service.
The first use of funds under a "gross lien revenue pledge" is to pay the: A. operation and maintenance fund B. debt service fund C. debt service reserve fund D. maintenance reserve fund
B. Under a gross revenue pledge, bondholders have claim to the gross revenues of the facility. After the debt service is paid, then operation and maintenance is paid. Contrast this with a "net revenue pledge." Under this pledge, bondholders only have claim to net revenues after operation and maintenance is paid. In this case, the first use of funds is to pay operation and maintenance.
A municipal bond is issued with a covenant that states "if revenue collections are insufficient, the state legislature has the authority, but not the obligation, to make an annual apportionment of funds necessary to meet debt service requirements." This is a: A. special tax bond B. double barreled bond C. moral obligation bond D. general obligation bond
C. A moral obligation bond is one under which the issuer has the authority, but not the obligation, to apportion the funds necessary to pay the debt service. The state is morally obligated to pay - but not legally obligated to pay.
A municipality would defease its debt with all of the following EXCEPT: A. U.S. Government securities B. U.S. Government agency securities C. AAA Corporate securities D. Bank certificates of deposit
C. A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA corporates would not be used because they have too high a level of credit risk (if things get bad, the corporation's credit rating could be downgraded; this is a highly unlikely event for government and agency securities).
Types of funds used to back revenue bond issues include all of the following EXCEPT: A. excise taxes B. lease rentals C. ad valorem taxes D. enterprise activity income
C. Ad valorem taxes back general obligation bonds. Revenue bonds can be backed by any source of revenue other than ad valorem taxes. These sources include revenue from facility operations, grants, excise taxes, or other non-ad valorem taxes, like sales and income taxes.
Periodic deposits of monies to the sinking fund are required to cover required: A. interest payments only B. principal payments only C. interest and principal payments D. interest payments and principal payments; and optional principal payments
C. Debt service is defined as payment of interest and principal as due. There is no requirement to fund optional deposits to a sinking fund. An issuer might make additional optional payments into the sinking fund to retire bonds by open market purchase, tender or call, if such would be advantageous to the issuer.
If a municipality is expecting to receive federal funding for mass-transit programs, it could borrow against the expected funds to be received by issuing: A. BANs B. TANs C. GANs D. CLNs
C. GAN stands for "Grant Anticipation Note." A GAN can be issued by a municipality to "pull forward" and get immediate use of federal grant monies that are expected to be received in the upcoming months. These federal grant monies are used for mass transit, energy conservation and pollution control improvements.
All of the following statements are true regarding a 5% municipal bond purchased at par that has a put option at par EXCEPT the: A. investor's yield cannot rise above 5% B. put would be exercised if interest rates rise C. put option will not affect the market risk of the security D. investor can exercise the put at his or her discretion
C. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.
An "in whole call" is a(n): A. mandatory call B. extraordinary mandatory call C. optional call D. extraordinary optional call
C. In the bond contract, the issuer may have the right to call in the entire issue at preset dates and prices (a normal call schedule, usually with at least 10 years of call protection given to the bondholder). The issuer has the option of calling in the bonds at those dates and prices; and will only do so if it is advantageous to the issuer (meaning that interest rates have dropped since the bonds were issued).
A municipality is at its constitutional debt limit. Voter approval would be required for a municipality to float a(n): A. revenue bond B. industrial revenue bond C. general obligation bond D. moral obligation bond
C. Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). To raise this limit requires a public referendum. Debt limits do not apply to self supporting debt such as revenue bonds. They also do not apply to moral obligation bonds, which the issuer does not legally have to pay (though the issuer is "morally" obligated to pay).
Under a net revenue pledge, once operation and maintenance costs are paid, what is the next item that is paid? A. debt service reserve fund B. reserve maintenance fund C. debt service expense D. renewal replacement
C. Net revenues are defined as gross revenues less operation and maintenance costs. Once operation and maintenance are covered, the net revenues that remain are first used to pay debt service.
The municipal bond counsel opines on all of the following EXCEPT: A. validity B. legality C. feasibility D. tax exempt status
C. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.
The municipal bond counsel opines on all of the following EXCEPT: A. validity B. legality C. marketability D. constitutionality
C. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render market or economic opinions, which is the same as rendering an opinion on the marketability of an issue.
All of the following statements are true regarding overlapping debt EXCEPT: A. overlapping debt is the debt of other governmental units shared by taxpayers in differing political subdivisions B. overlapping debt is apportioned among political subdivisions based upon relative assessed valuations C. overlapping debt is self-supporting, backed by a revenue pledge D. overlapping debt is usually structured as serial bonds backed by the full faith and credit of the issuer
C. The only debt that can be overlapping is G.O. debt - not revenue bonds. An overlapping debt is one shared by taxpayers in differing political subdivisions. For example, a school district may encompass 5 different towns. A portion of the school district debt overlaps each town, and the taxpayers in each town pay for the debt service on the school district debt based upon their relative assessed property valuations. G.O. bond issues are usually structured as serial bonds under a level debt service arrangement to match yearly payments to expected tax revenues.
A municipality would use general obligation bonds to finance all of the following EXCEPT the: A. addition to an existing school building B. construction of a new town hall C. construction of an industrial park D. addition of traffic lights to main intersections
C. The proceeds of general obligation bonds are used by municipalities to provide services to the general population - including the building and improvement of schools, police and fire department structures, and general municipal buildings. These bonds are serviced from general tax collections. Revenue bonds are used where there is a specific revenue source that can be pledged to bondholders to service the debt. Toll roads; toll bridges and tunnels; industrial parks where rents paid are the revenue source; water and sewer systems where separate water and sewer charges are imposed; are all typically built with revenue bond issues.
When analyzing municipal general obligation bonds of different issuers, it is difficult to use the ratio of Overall Debt / Assessed Valuation because: A. the ratio does not consider a municipality's ability to collect the taxes levied on all real property B. municipalities differ in their method of computing overall debt C. municipalities differ in their method of computing assessed value of properties D. the ratio does not consider the management capabilities of municipal government
C. The ratio of Overall Debt to Assessed Value of Property is a more difficult measure to use when comparing municipal issuers for safety because municipalities have differing methods of computing assessed values of properties, and such assessments tend to be quite subjective. The computation of Overall Debt is consistent across municipalities, so this is not a problem. The other choices do not address the characteristics of the components of the ratio.
Regarding the flow of funds set forth in a municipal bond contract, collected monies would FIRST be deposited to the: A. Operations and Maintenance Fund B. Debt Service Reserve Fund C. Revenue Fund D. Reserve Maintenance Fund
C. The trust indenture of a revenue bond issue includes a "flow of funds" - meaning how revenues will be applied by the issuer. As revenues are collected, they are deposited to a revenue fund, also called a general collection account. The monies are then applied, in sequence, to the operation and maintenance account; sinking fund; debt service reserve fund; reserve maintenance fund; renewal and replacement fund; and finally to the surplus fund.
A double barreled revenue bond is one which offers investors: A. double the normal interest rate due to the high risk factor B. both a high rate of interest and a high level of creditworthiness C. the choice of both term and serial maturities D. general obligation backing in addition to a revenue pledge
D. A "double barreled" bond is one backed by a specified source of revenue as well as the full faith and credit of an issuer with ad valorem taxing power. Revenue bonds are "double barreled" to increase the credit rating of the issue and hence reduce interest cost and increase marketability.
When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)? A. Both interest and principal payments are made semi-annually B. Interest is paid semi-annually and principal is paid at maturity C. Principal is paid semi-annually and interest is paid at maturity D. Both interest and principal are paid at maturity
D. A Capital Appreciation Bond (CAB) is a municipal zero coupon bond with a "legal" twist to it. A conventional zero coupon G.O. bond is counted against an issuer's debt limit at par value because the discount is treated as "principal." If a new issue discount bond is legally crafted as a CAB, then the principal counted against the issuer's debt limit is the discounted principal amount and the discount earned is considered to be interest income. The bond is purchased at the discounted price and then par is returned at maturity, with the 2 components of that par payment being the return of the discounted purchase price (the "principal" amount) and the accreted interest income.
Income sources backing a special tax bond issue could be all of the following EXCEPT: A. Excise taxes B. Sales taxes C. Income taxes D. Ad Valorem taxes
D. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales and income taxes).
All of the following callable municipal bonds are trading at a 5% basis. Which is MOST likely to be called? A. 3 3/4% coupon rate callable at 103 in 2016 B. 4 1/2% coupon rate callable at 103 in 2016 C. 5% coupon rate callable at 100 in 2016 D. 6 3/4% coupon rate callable at 100 in 2016
D. An issuer is most likely to call bonds which have high interest rates (high financing cost to the issuer) and low call premiums (the least expensive for the issuer to call in these bonds).
When analyzing a general obligation bond, all of the following ratios would be evaluated EXCEPT the: A. collection ratio B. debt per capita ratio C. debt to value ratio D. debt service coverage ratio
D. General obligation bonds are backed by faith, credit, and taxing power of the issuer. To analyze these bonds, it is important to examine the issuer's collection ratio (taxes collected / taxes assessed) to ascertain if the issuer is truly collecting all the taxes necessary to service the debt. The ratio of debt per capita would also be used to evaluate the relative debt burden per resident of one municipality as compared to another. The ratio of debt to assessed value of property would also be examined, since most G.O. bonds are backed by ad-valorem (property) tax collections. The debt service coverage ratio (ratio of pledged revenues to debt service requirements) is used to evaluate a revenue bond issue - not G.O. bonds.
All of the following statements are true regarding municipal bonds that have been called EXCEPT: A. interest ceases to accrue on the bonds B. the call price sets a ceiling on the market price of the bonds C. the holder may redeem the bonds at anytime D. the bonds will continue to trade "and interest"
D. If a bond issue is called, interest ceases to accrue as of the date specified in the call. Thus, the bond will now trade "flat" - that is, without accrued interest. The call price will set a ceiling on the market price of the bond. Meaning, the market price of the bond will never go above the call price; if it did and the bonds were called, investors would suffer a loss. The bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium. The call price would not set the floor on the market price of the bonds as the market could go below the call price (which could occur if market interest rates started to rise).
A municipality issues a zero-coupon bond that is callable at 104. If the municipality calls the bonds prior to maturity, the bondholder will receive: A. par B. 104% of par C. current accreted value D. 104% of current accreted value
D. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.
Which of the following municipal bonds would MOST likely be refunded by the issuer? A. 5% G.O., M '36, callable in 2016 at par B. 6% G.O., M '36, callable in 2016 at 102 C. 7% G.O., M '36, callable in 2016 at 102 D. 8% G.O., M '36, callable in 2016 at par
D. In a refunding, an issuer refinances an outstanding debt by issuing new bonds. The proceeds of the new issue are used to retire the old debt; or are placed in escrow to "pre-refund" an older issue that cannot be immediately repaid. This is either done to reduce interest cost or to remove an onerous restrictive covenant. The bonds most likely to be refunded are those with the highest interest rates (to be replaced by lower interest rate bonds) and low call premiums (so it will not be too expensive to the issuer to call in the debt for refunding).
Level debt service is best described as: A. debt service increases as the years progress B. debt service decreases as the years progress C. principal repayments decrease as the years progress D. principal repayments increase as the years progress
D. Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.
As stated in the flow of funds found in a revenue bond issue's trust indenture, monies left over after all other uses are exhausted are placed in the: A. Revenue Fund B. Debt Service Reserve Fund C. Sinking Fund D. General Surplus Fund
D. Monies left over after all other uses are exhausted are placed in the General Surplus Fund. These monies can be used in any legal way by the issuer.
Under a municipal revenue bond rate covenant, rates must be set to cover all of the following EXCEPT: A. operation of the facility B. debt service C. maintenance of the facility D. optional sinking fund deposits
D. Revenue bond rate covenants usually require that rates be set at a level sufficient to cover operation and maintenance of the facility, as well as debt service costs. There is no requirement to cover "optional" sinking fund deposits or reserve fund deposits.
A municipal issuer has sold housing bonds to build subsidized housing, where the homeowners make the mortgage payments to the municipal authority. The homeowners begin to prepay their mortgages at a faster than expected rate. If this occurs, the issuer will retire outstanding bonds by making a(n): A. mandatory call B. extraordinary mandatory call C. optional call D. extraordinary optional call
D. Since the homeowners are prepaying their mortgages faster than expected, the issuer will use the excess monies to call in outstanding bonds, rather than continue to pay interest on them. This call results from an extraordinary event, and is at the option of the issuer. Hence, it is an extraordinary optional call.
A municipal bond which funds an improvement that benefits only a small portion of the community is a: A. general obligation bond B. double barreled bond C. moral obligation bond D. special assessment bond
D. Special assessment bonds are used to fund an improvement which benefits only a small portion of the community. For example: new street lights are installed in a specific area where only that area is assessed higher taxes to pay for the improvement.
The feasibility study prepared in connection with a new municipal revenue bond offering is performed by the: A. issuer B. underwriter C. bond counsel D. independent consultant
D. The feasibility study in a revenue bond offering is a projection of building costs; expected revenues; and expenses. The net result should show that the revenues anticipated from the project are sufficient to pay for both operation and maintenance of the facility and interest expense on the bonds issued to finance the construction, as well as cover the repayment of the bonds. This study is performed by an independent consulting firm.
The revenue fund consists of: A. monies to pay for extraordinary maintenance or replacement costs B. monies to pay for regularly scheduled major repairs and replacement costs C. monies to meet debt service requirements D. all gross revenues from the facility
D. Under the flow of funds (which states the priority of collecting and disbursing pledged revenues), the revenue fund would contain all gross revenues from the facility. All monies to be disbursed are taken from this fund.
Variable rate municipal notes are NOT subject to which of the following risks? A. legislative risk B. default risk C. marketability risk D. interest rate risk
D. Variable rate municipal notes avoid market risk, also known as "interest rate risk." A rise in interest rates will not devalue these securities, since they can be put to the issuer at par at each weekly reset date. Thus, the price will not fall below par if interest rates rise. These notes are subject to legislative risk; marketability risk (Can they be liquidated quickly?); and default risk.
A municipality is at its debt limit and wishes to sell additional bonds. Voter approval is required for the municipality to sell: I General obligation bonds II Revenue bonds III Industrial revenue bonds
I. Voter approval is needed for a municipality to sell general obligation bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. Revenue bonds and industrial revenue bonds are not subject to debt limits because they are self-supporting and pay their own way from collected revenues. They are not paid from tax collections.
Which of the following information would be found in a municipal bond resolution? I Any restrictive covenants to which the issuer must adhere II Any call provisions providing for redemption prior to maturity as specified in the contract III The credit rating assigned to the issue by a nationally recognized ratings agency IV The compensation received by the underwriters for selling the issue to the public
I/II. The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions. The credit rating is given by the ratings agencies (e.g., Moody's or Standard and Poor's); and is found in their publications. The underwriter's compensation is disclosed to investors in new negotiated municipal bond offerings in the Official Statement (the disclosure document, similar to a prospectus, for new municipal issues).
Which of the following statements are true regarding Construction Loan Notes ("CLNs")? I The use of CLNs allows the municipal issuer to reduce its interest cost when constructing a new facility II The maturity of CLNs is generally 3 - 5 years III Accrued interest on CLNs is computed on an actual day month / actual day year basis IV When the facility is completed, the permanent financing is added to the outstanding balance ("basis") of the CLNs
I/II/III. Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing). CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 3 to 5 years, to coincide with the projected construction period of the building. Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year. Finally, the last statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.
Which of the following would be considered when evaluating the credit risk of a municipal revenue bond? I Management experience II The effect of competing facilities III Coverage ratios IV Collection ratios
I/II/III. Credit risk is the risk that the bond will default. To evaluate this risk for a revenue bond issue, one would examine coverage ratios; the effect of competing facilities; and the management of the facility. Collection ratios are only used to analyze G.O. bonds. The collection ratio shows the percentage of property taxes assessed that are actually collected by the municipality.
The ratio of net direct debt plus overlapping debt to assessed valuation of property is used to: I analyze general obligation bonds II evaluate the issuer's creditworthiness III evaluate the issuer's overall ability to service its debt burden IV evaluate the issuer's ability to collect taxes owed
I/II/III. The ratio of overall debt to assessed valuation is used to evaluate general obligation bonds (which are most often paid by ad valorem taxes). The lower the ratio, the better the creditworthiness of the issuer and the better able the issuer is to handle servicing the debt. However, the ratio does not indicate how good a job the municipality does collecting the taxes due. This is measured by the collection ratio - the ratio of taxes collected to taxes assessed.
A municipality has issued a general obligation bond. Which of the following are sources of income available for debt service? I Collected current ad valorem taxes II Collected back due ad valorem taxes III Fines IV Assessments
I/II/III/IV. General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues.
Which of the following statements are TRUE regarding a 5% municipal bond purchased at par that has a put option at par? I The yield on the bond can fall below 5% II The put would be exercised if interest rates rise III The holder can receive 100% of par for the bond if he or she exercises the put option IV The investor can exercise the put at his or her discretion
I/II/III/IV. If a bond has a put option at par, the holder can always exercise the put and "put" the bond back to the issuer, receiving 100% of par for that bond. Thus, as market interest rates rise, this bond's price will not fall, because it must always be worth par. Thus, such a bond is not susceptible to market risk. The yield on such a bond with a 5% coupon rate cannot rise above this level, because the price will not fall below par. However, the yield can drop below this level, because if interest rates fall, the bond's price will go to a premium and the put option would be worthless.
The bond counsel will review which of the following to ascertain if a municipal issuer has the authority to sell bonds? I State constitution II Validity of the signatures of the issuer's representatives III Enabling legislation IV Local statutes and judicial opinions
I/II/III/IV. The bond counsel will review all of the choices given to ascertain if a municipal issuer has the authority to sell bonds - the State constitution which gives those powers; any enabling legislation which affects the issuance of new bonds; any court opinions that are relevant; and the counsel will ascertain that the issuer's representatives are authorized to sell the bonds.
General obligation bond analysis would consider which of the following? I The trend of assessed values on the locality II The population trend in the locality III The record of tax collections IV The attitude of the community towards its debt
I/II/III/IV. To assess whether taxes are likely to be sufficient to pay off the debt, G.O. bond analysis includes evaluation of the tax collection record; trend of assessed valuation of property in the area; and debt to population ratios. In addition, the attitude of the community towards its debt (Do they intend to pay it off?) is becoming an important consideration in the wake of recent municipal defaults.
The income source backing a special tax bond issue could be: I Cigarette taxes II Sales taxes III Ad valorem taxes IV Business taxes
I/II/IV. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales, business or income taxes).
Municipalities would issue tax exempt commercial paper for which of the following reasons? I To smooth out collections of funds that are normally subject to seasonal fluctuations II To meet a temporary cash shortage due to unforeseen extraordinary expenses III To refund an outstanding bond issue IV To provide construction period financing that will be permanently financed by a future bond sale
I/II/IV. Municipal commercial paper is not very popular. Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short-term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a CLN - construction loan note). Commercial paper cannot be used for long term financing such as a bond refunding. Remember, commercial paper is a short term promissory obligation - not long term.
Revenue bonds may be called for which of the following reasons? I Homeowners have prepaid their mortgages II Interest rates have fallen III The issuer has reached a statutory debt limit IV The facility has been destroyed by fire
I/II/IV. Revenue bonds may be called if interest rates fall, allowing the issuer to refinance at the new lower rates; or can be called under extraordinary mandatory calls such as a calamity call if a disaster occurs destroying the facility; and can be called under extraordinary optional calls such as parts of a mortgage revenue bond issue being called if homeowners prepay their mortgages. Statutory debt limits do not apply to revenue bonds because they are self-supporting debts - they only apply to non-self supporting general obligation bonds.
The municipal bond counsel opines on which of the following? I Validity II Legality III Feasibility IV Tax exempt status
I/II/IV. The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.
An analysis of general obligation bonds would include: I examination of collection ratios II evaluation of engineer's reports III analysis of debt to value ratios IV analysis of debt service coverage ratios
I/III. General obligation bonds are backed by faith, credit, and taxing power of the issuer. To analyze these bonds, it is important to examine the issuer's collection ratio (taxes collected / taxes assessed) to ascertain if the issuer is truly collecting all the taxes necessary to service the debt. The ratio of debt to assessed value of property would also be examined, since most G.O. bonds are backed by ad-valorem (property) tax collections. Engineer's reports are examined when evaluating a revenue bond issue (e.g., is that bridge feasible?) and are not relevant to G.O. bonds. Similarly, the ratio of pledged revenues to debt service requirements (debt service coverage ratio) is used to evaluate a revenue bond issue - not G.O. bonds.
Which of the following statements are TRUE regarding municipal bonds that have been called? I Interest ceases to accrue on the bonds II Interest continues to accrue on the bonds III The holder may redeem the bonds at anytime IV The holder may only redeem the bonds on a regular semi-annual interest payment date
I/III. If a bond issue is called, interest ceases to accrue as of the date specified in the call, and the bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium.
Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The marketability of the advance refunded bonds will increase II The issuer redeems an old bond issue by advancing funds from the U.S. Government for this purpose III The funds to pay debt service requirements are deposited to an escrow account and used to buy U.S. Government securities IV The funds to pay debt service requirements are deposited to an escrow account and used to buy Municipal securities
I/III. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer. Municipal securities are not used for escrow in a prerefunding because they earn a lower rate of interest (since they are Federally tax-free) than Governments.
Which of the following statements are TRUE regarding a municipal bond issue that is advance refunded? I The security that backs the advance refunded bonds will change after the issue is refinanced II The security that backs the advance refunded bonds will not change after the issue is refinanced III The marketability of the advance refunded bonds will increase after the issue is refinanced IV The marketability of the advance refunded bonds will decrease after the issue is refinanced
I/III. In an advance refunding, the issuer floats a new bond issue and uses the proceeds to "retire" outstanding bonds that have not yet matured. These funds are deposited to an escrow account and are used to buy U.S. Government securities. The escrowed U.S. Government securities become the pledged revenue source backing the refunded bonds. These bonds no longer have claim to the original revenue source. Since there is a new source of backing for the bonds (and an extremely safe one!), the credit rating on the pre-refunded bonds increases, as does their marketability. The refunded bonds no longer have any claim to the original pledged revenues - and thus have been "defeased" - that is, removed as a liability of the issuer.
When monies are deposited into a sinking fund to retire municipal debt under mandatory call provisions found in the bond contract, the issuer: I calls bonds by random selection at preset dates and at preset prices II tenders for the bonds at preset dates and at preset prices III is permitted to retire outstanding bonds by making purchases of that issue in the open market IV is prohibited from retiring outstanding bonds by making purchases of that issue in the open market
I/III. When monies are deposited into a sinking fund to retire debt, the issuer has the choice of either calling in bonds at preset dates or buying the bonds in the open market. (The issuer will do whatever is cheaper). The specific bonds to be called are chosen by random lot.
Credit analysis of an airport authority revenue bond would include evaluation of which of the following? I Competing facilities II Overlapping debt III Debt coverage ratios IV Flow of funds
I/III/IV. Credit analysis of a revenue bond issue will include the impact of competing facilities; analysis of the flow of funds (e.g., is it a gross revenue pledge or a net revenue pledge?); and computation of the coverage ratios (Funds Available for Debt Service/Annual Debt Service Requirements). Overlapping debt is not relevant to revenue bond analysis - each revenue bond is self supporting. Overlapping debt is considered in a General Obligation bond analysis.
Mandatory sinking funds for municipal issues are: I found in revenue bond issues II not found in revenue bond issues III found in general obligation bond issues IV not found in general obligation bond issues
I/IV. A bond issue is likely to have a mandatory sinking fund if it is perceived as a risky issue, causing prospective purchasers to demand additional safeguards on their investment. Since G.O. bonds are backed by unlimited taxing power of the State, they are perceived as low risk (not needing a sinking fund). Revenue bonds are backed by the facility's revenues and are considered somewhat risky. These are the issues that are likely to have a mandatory sinking fund requirement.
A municipal bond that has a put option is protected against depreciation due to: I rising interest rates II falling interest rates III rising demand for the issue IV falling demand for the issue
I/IV. A bond with a put option allows the holder to put back the bond to the issuer at par value. Thus, this bond, once the put option is exercisable, is always worth at least par. Therefore, if interest rates rise or if market demand falls, this bond's price cannot fall below par (unlike traditional bonds).
Which of the following statements are TRUE regarding callable municipal issues? I Bonds are usually called when interest rates have declined II Bonds are usually called when interest rates have risen III Callable bond yields are lower than non-callable ones IV Callable bond yields are higher than non-callable ones
I/IV. Bonds are typically called when interest rates have fallen, allowing the issuer to refinance at a lower interest cost. Because of "call risk" - the risk that a high yielding issue can be called away if interest rates drop - callable bonds have higher yields than similar non-callable issues.
Municipal variable rate demand notes: I have a market value which will never go below par II have a market value which will never go above par III have a yield which will never fall below the stated rate IV have a yield which will never rise above the stated rate
I/IV. Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk and the yield cannot go above the stated rate. However, if interest rates fall, the price can go above par (by a small amount) and the yield can fall below the stated rate until the next reset date.
A municipal variable rate demand note is: I a short term issue II a long term issue III issued at short-term interest rates IV issued at long-term interest rates
II/III. A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to "put" the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.
Which of the following statements are TRUE regarding debt obligations? I Corporations issue revenue bonds II Municipalities issue revenue bonds III Corporations issue income bonds IV Municipalities issue income bonds
II/III. Corporations issue income bonds (also known as adjustment bonds) in times of corporate distress. These bonds obligate the issuer to pay only if the issuer has sufficient income. Municipalities issue revenue bonds, which pledge the revenues from a facility (such as a bridge or tunnel) to pay for the debt service on the bond issue.
To ease temporary cash flow shortages, municipalities will issue which of the following? I General obligation bonds II Tax anticipation notes III Revenue anticipation notes IV Moral obligation bonds
II/III. To ease a temporary cash flow shortage, municipalities will issue either TANs (Tax Anticipation Notes) or RANs (Revenue Anticipation Notes). These notes are paid off when the taxes or anticipated revenues are collected sometime in the near future. Long term bond issues (like General obligation bonds and moral obligation bonds) are not appropriate to meet cash flow shortages.
General obligation bond analysis would consider which of the following? I Protective covenants in the trust indenture II Trend of assessed valuation of property III Ratio of overall debt per capita IV Record of tax collections
II/III/IV. G.O. bonds are typically issued without a trust indenture - revenue bonds have trust indentures. The specific protections of an indenture are not needed since the municipality's taxing power is unconditionally pledged to pay off the bonds. Trust indentures are found in revenue bond issues, where only the revenues are pledged to pay off the debt, and purchasers of the bonds demand additional protections that are spelled out in the trust indenture, such as rate, insurance, and maintenance covenants. To assess whether taxes are likely to be sufficient to pay off the debt, G.O. bond analysis includes evaluation of the tax collection record; trend of assessed valuation of property in the area; and debt to population ratios.
Which of the following statements are TRUE regarding an institution using its endowment as a source of revenues pledged to bondholders? I The endowment fund itself is usually the source of revenue pledged II The earnings on the endowment fund are usually the source of revenue pledged III A water and sewer revenue bond is likely to have an endowment fund IV A hospital revenue bond is likely to have an endowment fund
II/IV. Hospitals are often given large monetary gifts - known as "endowments". The hospital invests the endowment funds to generate interest and dividend income. It usually agrees not to invade the principal amount. Thus, the earnings on the endowment funds (NOT the endowment fund itself) are a source of revenue that can be pledged to bondholders under a revenue pledge.
Special tax bonds are: I backed by ad valorem taxes II backed by sales or excise taxes III a self supporting debt IV a non-self supporting debt
II/IV. Special tax bonds are backed by taxes other than an ad valorem tax, such as liquor taxes, gasoline taxes, cigarette taxes or sales taxes. They are considered to be a non-self supporting debt since they are paid from tax collections. Self supporting debts are revenue bond issues that pay their own way from collected revenues.
Municipal variable rate demand notes: I have an interest rate that is fixed throughout the life of the bond II have an interest rate that is reset periodically III are considered short term municipal notes IV are considered long term municipal notes
II/IV. Variable rate bonds, also known as reset bonds, have a rate of interest that is reset periodically, usually weekly, based upon a recognized interest rate index that usually consists of Treasury Issues. At the reset date, the note is puttable back to the issuer at par (payable on demand of the holder, hence the term "demand note"). This was the first attempt by municipal issuers to sell long term bonds (because there is no stated maturity) at short-term interest rates (which are usually lower).
