Municipal Securities- Analysis, Trading and Taxation

Which of the following ratios is normally considered adequate coverage of interest and principal charges for a municipal revenue bond? A) 2 to 1. B) 1 to 1. C) 3 to 1. D) 7.5 to 1.

A) 2 to 1.

Which of the following choices is least similar to the others? A) Financial Guaranty Insurance Corp. B) Standard & Poor's. C) Moody's. D) Fitch.

A) Financial Guaranty Insurance Corp. Standard & Poor's, Fitch, and Moody's are all agencies that rate debt securities including municipals and equity securities as well. The Financial Guaranty Insurance Corp. is one of several entities that insure municipal bonds.

The function of a broker's broker in the municipal bond business is to do which of the following? Help sell municipal bonds that a syndicate has been unable to sell. Protect the identity of the firm on whose behalf the broker's broker is acting. Help prepare bids for an underwriting syndicate. Serve as a wholesaler, offering bonds at a discount from the current bid and offer. A) I and II. B) I and IV. C) II and III. D) III and IV.

A) I and II. A broker's broker helps sell any bonds a syndicate has left and does not disclose the identity of the firm on whose behalf it is acting. Brokers' brokers do not charge fees for quoting a security, do not maintain inventory, and act solely as agents.

A municipal issuer's total debt is made up of which of the following? Direct debt. Defeased debt. Overlapping debt. Paid-up debt. A) I and III. B) I and II. C) II and III. D) III and IV.

A) I and III. Direct debt is debt issued by the municipality, and overlapping debt is the municipality's share of debt issued by authorities that draw revenues from the same sources as the municipality. Together, direct debt and overlapping debt constitute the municipality's total debt.

Which of the following statements regarding municipal bonds with call provisions are TRUE? Call provisions are advantageous to the issuer. Call provisions are advantageous to the investor. Bonds are likely to be called in a falling interest rate environment. Bonds are likely to be called in a rising interest rate environment. A) I and III. B) I and IV. C) II and III. D) II and IV.

A) I and III. Municipal bond call provisions are advantageous to issuers because they provide the ability to redeem bonds before maturity to reduce fixed costs. Issuers call bonds when interest rates are falling. They issue new bonds at the new lower rate to raise the funds to call the outstanding bonds with the higher rate.

The interest from which of the following bonds is subject to federal income tax? State of Nebraska. City of Duluth. Treasury notes. FNMA. A) III and IV. B) I and II. C) I and III. D) II and IV.

A) III and IV.

Which of the following is the computation for the coverage ratio for a municipal revenue bond issue? A) Net revenue divided by annual interest and principal expense. B) Revenues collected divided by annual interest expense. C) Revenues collected divided by annual principal expense. D) Annual interest and principal expense divided by revenues collected.

A) Net revenue divided by annual interest and principal expense. Debt service coverage measures the amount of money available for debt service compared to the annual debt service requirements. Annual debt service includes both interest and principal expense.

Moody's Investment Grade (MIG) rating would be applicable to: A) a New York State revenue anticipation note. B) a New York state revenue bond. C) a New York State GO bond. D) a New York State university bond.

A) a New York State revenue anticipation note.

Before a firm distributes a prepared summary official statement for a new issue of municipal bonds to customers, it must have the written approval of the: A) firm's municipal securities principal. B) MSRB. C) issuer. D) bond attorney.

A) firm's municipal securities principal.

Net overall debt of a municipality is: A) net direct debt plus overlapping debt. B) net direct debt minus overlapping debt. C) funded debt plus overlapping debt. D) funded debt minus overlapping debt.

A) net direct debt plus overlapping debt. Net overall debt of a municipality is defined as net direct debt plus overlapping debt.

When a municipality is allocating funds from a revenue-producing facility under a net revenue pledge, the first priority is to: A) pay operations and maintenance. B) pay debt service, including principal and interest. C) establish a reserve for bond retirement. D) accumulate a surplus for facility expansion.

A) pay operations and maintenance.

In rating a general obligation (GO) bond, all of the following factors would be considered by an analyst EXCEPT A) the flow of funds B) the total outstanding debt C) the tax collection ratio D) the public's attitude toward debt

A) the flow of funds

Which of the following would be most likely to require a mandatory sinking fund? A) A PHA. B) A water and sewer revenue bond. C) A GO. D) A TAN.

B) A water and sewer revenue bond. Sinking funds force revenue bond issuers to set aside a portion of their revenue for debt retirement.

A resident of Minnesota is in the 28% federal tax bracket and the 4% state tax bracket. This person must pay both federal and state taxes on: A) Treasury bills. B) Federal National Mortgage Association pass-throughs. C) Minneapolis Housing Authority bonds. D) Federal Home Loan Bank notes.

B) Federal National Mortgage Association pass-throughs. The interest income from most U.S. government and agency securities is exempt from state and local, but not federal, taxes. Mortgage-backed securities (such as FNMA and GNMA obligations) are subject to federal, state, and local taxes. The interest on municipal issues (like the Minneapolis housing authority bonds) is exempt from federal taxes and, because this investor is a Minnesota resident, state taxes.

The ratio of taxes collected to taxes levied might be used in the analysis of which of the following bonds? A) IDR. B) GO. C) Pollution control. D) Water control.

B) GO

For which of the following would the net revenue to debt service ratio be applicable? A) School bonds. B) Hospital bonds. C) GO bonds. D) Tax anticipation notes.

B) Hospital bonds. This is the Coverage ratio. Because revenue bonds are only backed by funds generated by a specific source, it is important that net revenues exceed debt service requirements. Hospitals are often built with the proceeds of revenue bond issues.

A broker/dealer that is a financial advisor to a municipal issuer: I. Cannot act as an underwriter of the issuers bonds in a negotiated underwriting and receive compensation for both services. II. Cannot act as an underwriter of the issuers bonds in a competitive bid underwriting and receive compensation for both services. III. May always act as an underwriter of the issuers bonds in a negotiated underwriting and receive compensation for both services. IV. May always act as an underwriter of the issuers bonds in a competitive bid underwriting and receive compensation for both service. A) II and IV. B) I and II. C) I and III. D) II and III.

B) I and II. Broker/dealers acting as financial advisors to a municipality regarding a municipal issue are prohibited by MSRB Rule G-23 to also act as underwriters for the same issue regardless of whether the underwriting process has been done by competitive bid or was negotiated. In the event that an exception is allowed, or the broker dealer performs an advisory function specifically associated with the underwriting, the broker/dealer would be limited to accepting fees for the advisory service only and not be allowed to accept fees for any underwriting services.

Which of the following statements regarding callable municipal bonds are TRUE? Call premiums tend to increase over time. Call premiums tend to decrease over time. Call prices are stated as a percentage of the principal amount to be called. Call prices are stated as a percentage of the market value of the bonds to be called. A) II and IV. B) II and III. C) I and III. D) I and IV.

B) II and III.

Which of the following would be considered in analyzing the credit worthiness of a revenue bond issuer? Per capita debt. Debt service coverage. Management. Debt to assessed valuation. A) III and IV. B) II and III. C) I and II. D) I and IV.

B) II and III. Revenue bonds are paid out of revenues from a particular project or facility, not from tax revenue. Therefore, debt service coverage and the personnel in charge of managing the facility are important. Overall debt of the issuer would be important in analyzing a general obligation bond backed by the issuer's full faith and credit.

Which of the following is least important to a municipal bond analyst? A) Tax collection ratio. B) Legality of the issue. C) Debt service to annual revenues. D) Revenue collection record.

B) Legality of the issue. Municipal bond analysts are concerned with the financial aspects of municipal bonds to ensure that they do not default. Various financial ratios and collection records are critical to their analysis. The legality of the municipal issue, as determined by the legal opinion, is important to issuers.

Which of the following insures general obligation bonds? A) Syndicate manager. B) National Public Finance Guarantee Corp. and AMBAC. C) SIPC. D) FDIC.

B) National Public Finance Guarantee Corp. and AMBAC. Outstanding municipal general obligation bonds have been insured by the National Public Finance Guarantee Corp. and AMBAC. Insured bonds are typically AAA implied rated. SIPC protects customer accounts against broker/dealer failure. The FDIC protects customer deposits against bank failure.

Which of the following is NOT considered when trying to diversify a municipal bond portfolio? A) Maturity. B) Price. C) Quality. D) Geographical location.

B) Price. One of the purposes of diversifying a municipal bond portfolio is to spread the risk among the portfolio's issues. This can be accomplished by buying bonds of differing maturities, geographical locations, and quality.

All of the following must be considered by an investment adviser representative before recommending a municipal security to a customer EXCEPT: A) Municipal security's rating. B) The municipality's coverage ratio. C) Customer's state of residence. D) Customer's tax status.

B) The municipality's coverage ratio. The coverage ratio is specific to revenue bonds only and tells how many times annual revenue from that issue will cover the debt service of the issue. It is not a factor of suitability to be considered when recommending a municipal bond but more of a factor to consider when comparing two municipal revenue bonds. The customer's state of residence and tax status are essential when determining suitability for a municipal security. The security's rating is also important because it measures the overall safety and quality of the bond.

All of the following statements regarding a municipality's collection ratio are true EXCEPT: A) the collection ratio measures the municipality's property tax collections. B) a poor collection ratio might mean the municipality is likely to default on its revenue bonds. C) the collection ratio is calculated as follows: taxes collected divided by taxes assessed. D) a high collection ratio is more favorable than a low collection ratio.

B) a poor collection ratio might mean the municipality is likely to default on its revenue bonds. The collection ratio measures taxes collected versus taxes assessed. It is a tool used in analyzing GO bonds, which are backed by the taxing authority of the issuer. Revenue bonds are backed by user fees, not taxes.

With bonds subject to a gross revenue pledge, the first priority will be to pay: A) the sinking fund. B) bond interest and principal. C) operation and maintenance . D) the first lien on the property.

B) bond interest and principal. Gross if you don't make operations & maintenance a priority

An aluminum recycling plant has been financed via a revenue bond issued under a net pledge. All of the following costs would be deducted from gross revenue to determine the amount available for debt service EXCEPT: A) treatment costs. B) depreciation. C) plant maintenance costs. D) transportation costs.

B) depreciation. A net revenue pledge requires the issuer to pay for operating and maintenance costs before meeting debt service requirements. Depreciation does not represent a cash outflow; it is a noncash deduction.

A municipality is allocating the revenues from an industrial revenue bond under a net revenue pledge. The first priority is: A) reserve funds. B) operation and maintenance. C) bond interest. D) sinking fund payment.

B) operation and maintenance.

In analyzing a municipal government obligation bond, an increase in all of the following would be a negative indication EXCEPT: A) unemployment. B) property values. C) delinquent taxes. D) municipal operating expenses.

B) property values.

Interest received on a California general obligation bond purchased by a San Francisco resident is exempt from: A) capital gains taxes only. B) state and federal income taxes. C) federal income tax only. D) state income tax only.

B) state and federal income taxes.

After an extensive feasibility study on the viability of a new shopping mall, the City of Mt. Vernon decided to issue bonds that depend on the earning requirements of the facilities. All of the following statements are true EXCEPT that: A) rental revenues collected from shop owners within the mall will pay the bonds debt service. B) the bonds are backed by the full faith and credit of the City of Mt. Vernon. C) the city is issuing revenue bonds. D) investor risk depends on the specific characteristics of the project.

B) the bonds are backed by the full faith and credit of the City of Mt. Vernon.

All of the following might affect the credit rating of a municipal revenue issue EXCEPT: A) the quality of the facilities management. B) the tax rates of nearby municipalities. C) the rate covenants set forth in the indenture. D) the debt service coverage ratio.

B) the tax rates of nearby municipalities. The credit rating of a revenue issue would not be affected by tax rates in surrounding municipalities.

Debt service is best described as the: A) net interest on a new issue of a municipal bond . B) total of interest and principal payable by the issuer plus any amount required to be deposited into a sinking fund. C) services provided by the paying agent for a bond issue. D) total of the direct debt of a municipality and the debt of its political subdivisions.

B) total of interest and principal payable by the issuer plus any amount required to be deposited into a sinking fund. Debt service is the total of interest and principal payable by the issuer plus any amount required to be deposited into a sinking fund.

A municipal revenue bond indenture contains a net revenue pledge. The following are reported for the year: $30 million of gross revenues, $18 million of operating expenses, $4 million of interest expenses, and $2 million of principal repayment. What is the debt service coverage ratio? A) 9:1. B) 3:1. C) 2:1. D) 5:1.

C) 2:1. Under a net revenue pledge, bondholders are paid from net revenue, which equals gross revenue minus operating and maintenance expenses. In this example, net revenue is $12 million ($30 million − $18 million). Debt service is the combination of interest and principal repayment. Here, debt service is $6 million ($4 million + $2 million). To compute the debt service ratio, divide net revenue by debt service: $12 million / $6 million = a ratio of 2 to 1.

An investor is considering purchasing a bond. He has settled on either a 6% municipal bond offered by the state in which he lives or an 8% corporate bond offered by a company with headquarters in his state. He would like you to help him decide which bond will get him the greatest return for his investment. Which of the following items of information must you obtain before you can make a specific recommendation? A) What other securities he owns. B) His net worth. C) His tax bracket. D) How long he has been a resident of his state.

C) His tax bracket.

In what order are distributions paid under a net revenue pledge? The surplus fund. The debt service account. The operations and maintenance fund. The debt service reserve account. A) III, IV, II and I. B) III, II, I and IV. C) III, II, IV and I. D) I, II, III and IV.

C) III, II, IV and I. Under a net revenue pledge operations and maintenance expenses are paid before all debt service. Therefore payments go out to cover expenses in the following order: (1) operating and maintenance expenses, (2) debt service, (3) debt service reserve, and (4) surplus.

An insured municipal bond is purchased by your client in the secondary market. After the sale, MSRB rules would require you to: A) send a copy of the Official Statement. B) indicate that the bonds are insured on the confirmation because this is the only requirement. C) make delivery of the certificates accompanied by evidence of insurance, either on the face of the certificates or in a separate document. D) include a copy of the insurance policy with delivery of the certificates.

C) make delivery of the certificates accompanied by evidence of insurance, either on the face of the certificates or in a separate document.

Moody's Investment Grade (MIG) Ratings are applied to: A) corporate bonds. B) money market instruments. C) municipal notes. D) municipal bonds.

C) municipal notes.

The call premium on a municipal bond trading above par is best described as the difference between: A) the market price and the call price. B) the amortized premium and the annual interest. C) par and the call price. D) the market price and par.

C) par and the call price. The call premium represents the difference between the call price and par. The farther away a call date, the lower the call premium.

All of the following statements regarding a municipality's debt limit are true EXCEPT that: A) revenue bonds are not affected by statutory limitations. B) unlimited GO bonds may be issued when a community's taxing power is not restricted by statutory provisions. C) the debt limit is the maximum amount a municipality can borrow in any one year. D) the purpose of debt limits is to protect taxpayers from excessive taxes.

C) the debt limit is the maximum amount a municipality can borrow in any one year. The debt limit is the maximum amount of debt a municipality can have outstanding.

All of the following statements regarding municipal revenue bonds are true EXCEPT: A) no debt limitation is set by the issuing municipality . B) revenue bonds can be issued by inter- or intrastate authorities. C) the maturity of the revenue bond will usually exceed the useful life of the facility being built. D) the interest and principal are paid from revenue received from the facility.

C) the maturity of the revenue bond will usually exceed the useful life of the facility being built.

The purchaser of a GO municipal bond should be concerned with property tax assessments the maintenance covenant market risk feasibility studies A) I and IV B) II and III C) II and IV D) I and III

D) I and III GO bonds are issued by municipalities and, like all debt instruments, are subject to interest rate changes (market risk). Ad valorem (property taxes) are the primary source of debt funding for municipal GO bonds and are based on property assessments. Feasibility studies and maintenance covenants are associated with municipal revenue bonds where user fees from municipal projects and facilities are used to fund the debt.

In the analysis of a general obligation bond issued by a county, negative factors would include an increase in assessed property values. an increase in the county's unemployment rate. an increase in the percentage of tax payment delinquencies. an increase in the number of office buildings being rehabilitated. A) I and II. B) I and IV. C) III and IV. D) II and III.

D) II and III. Since general obligation bonds are backed by taxes, an increase in tax delinquencies is negative. When unemployment rates increase, it could lead to an inability of the residents to keep current with their taxes.

All of the following would be indications of a deteriorating credit situation EXCEPT: A) an increase in the per capita debt. B) an increase in tax delinquencies. C) an increase in personal bankruptcies. D) an increase in municipal assessed valuations.

D) an increase in municipal assessed valuations. An increase in assessed property values would theoretically mean an increase in taxes collected, thus increasing a municipality's credit standing.

Municipal bonds are not normally sold short because: A) short sales are prohibited by municipal statute. B) short sales are prohibited by MSRB rules. C) the transaction is expensive to execute. D) the municipal bond market is illiquid.

D) the municipal bond market is illiquid. While there is no law or industry rule prohibiting short sale of municipal bonds, it is not a common practice. To short a security, it must be borrowed, and because most municipal securities are thinly traded, it is often difficult to locate the specific issue needed to cover the short position.

A municipal bond rating service would consider all of the following when evaluating a revenue bond EXCEPT: A) operating revenues. B) the public's attitude toward debt. C) the debt service coverage ratio. D) feasibility studies.

Debt service coverage ratio, feasibility studies, and projected operating revenues are important to the analysis of a municipal revenue bond. The public's attitude toward debt is relevant in evaluating GO bonds, which are backed by the taxing authority of the issuer.

Which of the following governmental bodies receive the least amount of their revenues from property taxes? A) Municipalities. B) School districts. C) State governments. D) County governments.

State governments generally do not assess property (ad valorem) taxes. These are assessed by local governments. Generally, state governments receive most of their income from sales and income taxes.

All of the following would be considered when evaluating a municipal revenue bond's creditworthiness EXCEPT: A) management expense. B) competing facilities. C) collection ratio. D) coverage ratio.

The collection ratio shows the percentage of property taxes that are actually collected. This would be relevant in evaluating GO bonds, which are backed by the taxing authority of the issuer. Revenue bonds, however, are backed by user fees, not taxes.

All of the following should be considered when creating a diversified municipal bond portfolio EXCEPT: A) credit rating. B) geographic location of the issuer. C) revenue source backing the bonds. D) denomination of the bonds included in the portfolio.

The denomination of the bonds in a portfolio is not relevant to diversification.