Municipal Debt

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

Information about the municipal secondary market can be obtained from all of the following EXCEPT: A Daily Bond Buyer B Bloomberg C Munifacts D EMMA

A

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

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

A customer in the 28% tax bracket is considering the purchase of a municipal bond yielding 8% or a corporate bond yielding 11%. Both bonds have similar maturities and credit ratings. Which statement is TRUE? A The effective yield on the municipal bond is higher B The effective yield on the corporate bond is higher C Both effective yields are equivalent D The coupon rates for each bond are necessary to determine the effective yield

A Equivalent Taxable Yield = (Tax Free Yield/ 100% - Tax Bracket%) Equivalent Tax Free Yield = Taxable Yield * (100% - Tax Bracket%)

Interest income from which of the following bonds is most likely to be considered a "tax preference item" in the Alternative Minimum Tax calculation? A Airport revenue bond B Hospital revenue bond C Water revenue bond D General obligation bond

A Municipal "Private Activity Bonds" are taxable - the interest income is subject to federal income tax. If the PAB is "qualified," then the interest income is not subject to regular income tax, but it is a tax preference item included in the AMT calculation (which typically only hits higher income taxpayers who take a lot of deductions). Qualified PABs include bonds where the proceeds go to finance the activities of a private entity, including airports, docks, residential rental projects that are privately owned, waste disposal projects, water and sewer facilities that are privately owned and enterprise zones. Note that if any of these activities were being done by public entities, the bonds would be tax-free.

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 bondsII Revenue bondsIII Industrial revenue bonds A I only B I and II only C II and III only D I, II, III

A 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 actions must be taken if a municipality wishes to raise its debt limit? A Public referendum B Court order C Judicial edict D Tax assessment

A Public referendum 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.

The formula for a municipality's collection ratio is: A taxes collected / taxes assessed B taxes assessed / taxes collected C taxes assessed * taxes collected D (taxes collected + assessed property values) / taxes assessed

A taxes collected / taxes assessed

Which of the following municipal bonds will trade "flat" ? I Defaulted bondsII Zero-coupon bondsIII Moral obligation BondsIV General obligation bonds A I and II only B III and IV only C I, II, III D I, II, III, IV

A. Bonds that are not making interest payments trade flat (without accrued interest). In this category are defaulted bonds and zero-coupon bonds. Moral obligation bonds and general obligation bonds trade with accrued interest - these make interest payments twice per year (unless they default!)

A customer would ask for a bond appraisal when selling a municipal bond: I because there is little or no active trading market for municipal bondsII because there is an active trading market for municipal bondsIII to obtain an indication of the likely market price of the bondIV to obtain a firm bid on the bonds A I and III B I and IV C II and III D II and IV

A. Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.

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

nterest income from which of the following securities is subject to State and Local tax? A Treasury Bonds B Federal National Mortgage Association Bonds C Federal Home Loan Bank Bonds D Puerto Rico Bonds

B Federal National Mortgage Association Bonds B. As a rule, interest income from U.S. Government securities is subject to Federal tax and exempt from State and Local tax. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from securities issued by the housing agencies that sell pass through certificates is fully taxable. These are: Federal National Mortgage Association ("Fannie Mae") Government National Mortgage Association ("Ginnie Mae") Federal Home Loan Mortgage Corporation ("Freddie Mac") Interest income received from bonds issued by territories or possessions is always triple exempt.

Special assessment bond issues are paid from: A taxes levied upon all taxable property within the municipality, without limitation as to rate or amount B taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement C revenues pledged from the operation of a facility built with the proceeds of the issue D excise taxes placed upon the sale of either alcohol, tobacco, or fuel

B taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement

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 the interest is federally tax exempt

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 - property tax 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). Review

A customer wishes to determine the call provisions on a municipal bond that he currently holds. Which source provides this information? A Munifacts B EMMA C The OTCBB D The Bond Buyer

B EMMA

A bank wishes to make an investment in municipal bonds. The most advantageous security for this investor is a: A banker's acceptance B bank qualified municipal bond C BAN D bearer bond

B. Bank qualified municipal bonds are small dollar issues (less than $10,000,000) of General Obligation bonds. If a bank invests in these bonds, it is given a substantial tax break - 80% of the interest cost of carrying bank deposits that funded the purchase of those bonds is tax deductible to the bank. This benefit is only available on bank qualified issues. It does not apply to bankers' acceptances (a type of money market instrument); Bond Anticipation Notes; or bearer bonds. Review

Bond appraisals are used in the municipal secondary market because: I the market is thinII the market is activeIII trades are reported to a consolidated tapeIV trades are not reported to a consolidated tape A I and III B I and IV C II and III D II and IV

B. Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.

If a bond is trading at a premium, price volatility is greatest for a bond having: I coupon rates slightly above the market interest rateII coupon rates greatly above the market interest rateIII short term maturitiesIV long term maturities A I and III B I and IV C II and III D II and IV

B. The basic truths about bond price volatility are:The lower the coupon rate (the same as saying the lower the price of the bond), the greater the bond price volatility; The longer the maturity, the greater the bond price volatility. Bonds trading at low premiums have a lower price than bonds trading at high premiums. Thus, of the choices given, a bond with a low premium (a coupon only slightly higher than the market interest rate) and a long maturity would have the greatest price volatility. Review

Which of the following bond issues would most likely have a mandatory sinking fund? I U.S. Government bondII General Obligation bondIII Hospital Revenue bondIV Airport Revenue bond A I and II only B III and IV only C II, III, IV D I, II, III, IV

B. A bond issue is likely to have a mandatory sinking fund provision if it is perceived to be somewhat risky causing potential purchasers to demand this additional safeguard. Treasury Bonds are backed by the full faith and credit of the U.S. Government, so these issues have no credit risk. State General Obligation bonds are backed by the unlimited taxing power of the State, and also are perceived to be of low risk. Hospital Revenue bonds and Airport Revenue bonds are backed solely by the facility's revenues and are considered to be somewhat risky. (If there is hospital overbuilding or patient stays are shortened, revenues can fall; if another airport is built nearby that takes away passengers, revenues can fall; etc.)

Which of the following insure municipal bonds? I FDICII AMBACIII MBIAIV SIPC A I and II only B II and III only C I and IV only D I, II, III, IV

B. FDIC - Federal Deposit Insurance Corporation - insures bank deposits against bank failure. SIPC - Securities Investor Protection Corporation - insures brokerage firm accounts against broker-dealer failure. MBIA - Municipal Bond Insurance Association Corporation and AMBAC - American Municipal Bond Assurance Corporation, both insure municipal issues against default. Review

The manager of a pension plan would invest in all of the following debt securities EXCEPT: A Corporate bonds B Municipal bonds C U.S. government bonds D Foreign government bonds

B. Income from securities held in Pension Plans is tax deferred; so there is no benefit to investing in municipals, which have lower rates because their interest income is exempt from Federal income tax. Investments would be made in corporate and government bonds (both U.S. government obligations and foreign government obligations, such as Canadian government bonds), both of which have higher interest rates because their interest income is taxable by the Federal government.

Ultimate payment of debt service on moral obligation bonds is dependent upon: A Earnings coverage B Legislative apportionment C Judicial edict D Court validation

B. Moral obligation bonds are political subdivision (such as a city) issues that obligate the city to pay debt service but additionally, are backed by the State's "moral" obligation to pay. If the city cannot pay, these moral obligation bonds are paid only if the State legislature apportions the funds to service the debt. There is a moral obligation on the part of the State to pay; but not a legal obligation to pay.

25 Basis Points equal: A $.25 B $2.50 C $25.00 D $250.00

B. One basis point = .01% in interest, or .01% of $1,000 par in annual interest = $.10. 25 basis points equal .25% of annual interest on a $1,000 per bond = $2.50.

A double barreled bond is one backed by a pledged source of revenue, as well as: A the guarantee of the U.S. Government B U.S. Government Treasury Bonds held in trust C the pledge of the municipality's ad valorem taxing power D the municipality's moral obligation to pay

C

A "double barreled" municipal issue has: I primary backing of a general obligation pledgeII primary backing of a revenue pledgeIII secondary backing of a general obligation pledgeIV secondary backing of a revenue pledge A I and III B I and IV C II and III D II and IV

C A "double barreled" bond is a municipal revenue bond whose principal and interest payments are backed by a revenue pledge; however, if the revenues are insufficient to cover the debt service requirements, the municipality will use its ad valorem taxing power to meet the deficit. Review

A calamity call covenant would be activated for which of the following reasons? I Earthquake damage has incapacitated a facility II Flooding has inundated a facility III Fire has incinerated a facility IV Obsolescence has caused the mothballing of a facility A II and III only B I and IV only C I, II, III D I, II, III, IV

C Catastrophes are "sudden" occurrences, such as flooding, hurricanes, fires, earthquakes, etc. Damage from all of these could activate a calamity call covenant. Obsolescence does not factor into this definition.

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.

What is considered to be the most positive factor when evaluating the credit of a general obligation bond of a city? A Increasing real property values B Increasing income of residents C Increasing tax base D Increasing number of residents

C Increasing tax base

The interest income earned on which of the following municipal bonds would be included in the alternative minimum tax computation? A School District Bond B Turnpike Revenue Bond C Industrial Revenue Bond D Water District Revenue Bond

C Industrial Revenue Bond The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O.'s, and public facility revenue issues are not subject to the alternative minimum tax (AMT).

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 general obligation bond

The interest received from older "tax free" Industrial Development Bond (IDBs) issues is taxable if the holder of these bonds is: A a customer B a broker/dealer C the corporate lessee D a bank

C the corporate lessee The interest income earned from Industrial Development Bond Issues that were issued prior to 1986 was generally tax exempt. 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.

The listing of current municipal bond offerings shows the following: Cook County School District Bond3.20 couponM '201.50 Which of the following statements are TRUE? I The bonds will be prerefunded in 2020II The bonds mature in 2020III The bond is trading at a premiumIV The bond is trading at a discount A I and III B I and IV C II and III D II and IV

C. M in this instance means maturing in the year 2020. Since the bonds are currently offered at a price to yield 1.50%, which is lower than the coupon of 3.20%, the bond is trading at a premium.

Which statements are TRUE about a Certificate of Participation (COP)? I COPs are considered to be a general obligation of the issuer II COPs are considered to be backed by a revenue pledge III Payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds IV Payments to security holders are not contingent on the governing body making an annual appropriation from budgeted funds A I and III B I and IV C II and III D II and IV

C. 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.

Which of the following projects would be financed by a revenue bond issue? I The construction of a new subway lineII The construction of a new junior high schoolIII The construction of a new hydroelectric generating plantIV The construction of a new sewage treatment plant A I and II only B III and IV only C I, III, IV D I, II, III, IV

C. Public schools do not produce revenue and thus are not funded by revenue bond issues. Rather, school bond issues are general obligations of the issuer. A subway line, hydroelectric plant, and sewage treatment plant all charge for their use and can be financed with revenue bonds.

When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)? I Interest is paid semi-annuallyII Interest is paid at maturityIII Principal is paid semi-annuallyIV Principal is paid at maturity A I and III B I and IV C II and III D II and IV

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.

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

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

Under the flow of funds in a revenue bond trust indenture, net revenue is defined as gross revenue minus: A sinking fund expenses B debt service reserve expenses C debt service expenses D operation and maintenance expenses

D

A municipal "GAN" could be backed by all of the following EXCEPT: A Federal transit assistance monies B Federal pollution control assistance monies C Federal energy conservation assistance monies D Federal tax collection monies

D Federal tax collection monies

All of the following would be found in a municipal bond resolution EXCEPT: A the issuer's duties to the bondholders B the nature of the obligation C any restrictive covenants to which the issuer must adhere D any costs to be paid by the issuer in connection with issuing the bonds

D any costs to be paid by the issuer in connection with issuing the bonds The bond resolution (or bond contract) is the contract between the issuer and the bondholder. It spells out the nature of the obligation; the issuer's duties to the bondholders; and any restrictive covenants to which the issuer must adhere. Any costs that the issuer incurs to sell the bonds has no bearing on the bond contract, since the bondholder is not involved in these expenses - they are solely the responsibility of the issuer. Review

Special tax bonds are: I backed by ad valorem taxes II backed by sales or excise taxes III a self supporting debt when analyzing the Debt Statement of a town IV a non-self supporting debt when analyzing the Debt Statement of a town

D. 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. When ratings agencies such as Standard and Poor's look at the Debt Statement of a municipality to assign a credit rating, they will not deduct special tax bonds from Total Bonded Debt when calculating Net Direct Debt (All Bonded Debt Sold - Self Supporting Debt). They say that they treat Special Tax bonds as non-self supporting debt because, to be conservative, they consider ALL types of taxes paid by the population of a town to service its debt when calculating Net Bonded Debt.

Municipal bonds would be an appropriate investment for which of the following? I IndividualsII Individual Retirement AccountsIII Bank Holding CompaniesIV Casualty Companies A II, III, IV B I, II, III C I, II, IV D I, III, IV

D. It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments into the account.

A customer holds a very large, diversified portfolio of high grade municipal bonds with varying maturities. This customer has minimized all of the following risks EXCEPT: A default risk B interest rate risk C marketability risk D legislative risk

D. Legislative Risk Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the interest income on the bonds. This risk cannot be diversified away. Default risk is minimized with a diversified portfolio; interest rate risk is minimized by mixing maturities. Marketability risk is also reduced by diversification, since it is unlikely that all the issues in the portfolio would become unmarketable at one time.

Which of the following municipal bonds should be trading at the lowest dollar price? A 4.80 coupon; 7.10 basis; M '20 B 6.80 coupon; 8.30 basis; M '30 C 7.20 coupon; 6.50 basis; M '35 D 6.00 coupon; 8.60 basis; M '40

D. The basic truths about bond price movements caused by changes in market interest rates are: 1. The longer the maturity, the greater the price will move for a given change in interest rates. 2. The deeper the discount on the bond (caused by the coupon being lower than the market rate of interest), the greater the price will move for a given change in interest rates. Choice D is both a very long maturity, and a relatively low coupon compared to current interest rates (the basis is the fairest representation of current market rates for that type of issue), so it would be trading at the deepest discount. While Choice A has an even lower coupon, its very short maturity would reduce the bond's potential price drop as market interest rates rise. This is true because the essential truth is that this short maturity bond must be worth par at redemption in just a few years, so its price cannot drop very much below this level.

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 fac

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.

From an issuer's standpoint, as the years progress, "level debt service" serial bond issues have: I Decreasing interest payment amountsII Increasing interest payment amountsIII Decreasing principal repayment amountsIV Increasing principal repayment amounts A I and III B I and IV C II and III D II and IV

I Decreasing interest payment amounts IV Increasing principal repayment amounts 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 (similar to a mortgage amortization schedule). Since bonds are retired annually, the amount of the payment representing interest declines annually. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases.

Under a municipal revenue bond rate covenant, charges for the use of a facility must be set at a level sufficient to cover: I Operation and maintenance of the facility II Debt service and mandatory deposits to the debt service reserve fund III Optional sinking fund deposits IV Deposits to the reserve maintenance fund

I Operation and maintenance of the facility II Debt service and mandatory deposits to the debt service reserve fund

A municipal dealer offers bonds to another dealer "firm for one-half hour with a five minute recall." This means that the: I selling dealer cannot change the price for one-half hour II selling dealer cannot change the price for the next five minutes III selling dealer has the right to contact the other dealer during the half hour to change the quote if a transaction does not take place in the next five minutes IV buying dealer must call back the selling dealer in five minutes if it wishes to purchase the bonds

I and III The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period the buying dealer can try and round up a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.

Municipal variable rate demand notes: I have a minimum value which will never go below par II have a maximum value which will never go above par III are subject to market risk IV are not subject to market risk

I and IV - Variable Rate Notes have ALMOST NO MARKET RISK - Unlike bonds with fixed interest rates, "reset" bonds will show very little price fluctuation in response to market interest rate movements, since the interest rate is being reset to the prevailing market rate daily or weekly. Thus, the price tends to stay at, or close to, par.

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 Municipalities issue revenue bonds III Corporations issue income bonds 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.

A municipality has a tax rate of 12 mills. A piece of real property in the municipality is assessed at $225,000 and has a fair market value of $250,000. The annual tax liability on the property is: A $120 B $300 C $2,700 D $3,000

One mill = .001; 12 mills = .012. Taxes are based on assessed valuation, not fair market value. .012 x $225,000 = $2,700. Another way to think about it is that 1 mill = $1 of tax for each $1,000 of assessed value.

What percentage of the interest expenses incurred on funds used to buy bank qualified bonds is deductible to a bank investor? A 0% B 20% C 80% D 100%

c. 80% If a bank purchases "bank qualified" municipal bonds, the bank receives interest income on the bonds that is 100% free of Federal tax; yet the bank is still allowed to deduct 80% of any interest expense that it must pay on monies borrowed to buy those bonds. (The bank "borrows" the monies from its depositors and pays them interest on their deposits). Please note that if an individual were to buy municipal bonds, the interest expense on monies used to buy the bonds is non- deductible, since the interest income isn't Federally taxable.

Flow of Funds

the priority of disbursing the revenues collected - Revenue fund - operation and maintenance fund -debt services reserve fund - reserve maintenance fund - renewal and replacement fund - surplus fund