Topic by Topic Municipal
An individual's home has a resale value of $500,000 and an assessed value of $200,000. If the tax rate is 10 mills, the property tax is: $2,000 $5,000 $20,000 $50,000
$2,000 Property tax is computed by multiplying the assessed value by the millage rate. A mill equals 0.001 or $1 per $1,000 assessed value. The tax is $2,000 ($200,000 x .001 x 10 mills).
An investor purchases a $100,000 face value municipal bond with a 5-year maturity at 105. After two years, the bond is sold at 95. For tax purposes, the investor has a(n): $2,000 loss $4,000 loss $8,000 loss $10,000 loss
$8,000 loss When a municipal bond is purchased at a premium, the bond's premium must be amortized to find an adjusted cost basis. If the bond is sold above the adjusted cost basis, the result is a capital gain. If the bond is sold below the adjusted cost basis, the result is a capital loss. If the bond is held to maturity, there is neither a loss nor a gain for tax purposes. This is because the adjusted basis would equal the par value after the premium is amortized. This bond is purchased at $105,000 with a 5-year maturity. The premium of $5,000 ($105,000 - $100,000 = $5,000) must be amortized over a 5-year period ($5,000 divided by 5 years equals $1,000 per year). Therefore, each year the original cost of the bond is reduced by $1,000. If the bond is sold after 2 years, the adjusted cost basis is $103,000 ($105,000 - $2,000 = $103,000). Since the bond is sold at $95,000, there is a capital loss of $8,000 ($103,000 - $95,000)
An investor buys a 5% municipal bond at 102 1/2. The bond has a yield to maturity of 4 1/2%. If the investor holds the bond to maturity, he will have a loss for tax purposes of: 0 $25 $50 $100
0 The IRS requires that a premium paid for a municipal bond be amortized over the life of the bond. At maturity, the investor will have an adjusted cost (after amortization) of par ($1,000). Since this is the amount received at maturity, there is no loss for tax purposes.
A municipal revenue bond is secured by the revenues of a toll road system showing the following information. Annual Debt Service $3,000,000 Annual Gross Revenues $6,000,000 Annual Operating and Maintenance Expenses $2,000,000 Based on this information, the annual debt service coverage ratio is: .667 to 1 1.33 to 1 2 to 1 3 to 1
1.33 to 1 The debt service coverage ratio for the municipal revenue bond is 1.33 to 1. The formula for the debt service coverage ratio is net revenues divided by the annual debt service. The information listed in the question is as follows. Annual Debt Service $3,000,000 Annual Gross Revenues $6,000,000 Annual Operating and Maintenance Expenses $2,000,000 Step 1: Calculate the net revenue for the municipal revenue bond. Annual Gross Revenues $6,000,000 - Annual O/M Expenses $2,000,000 Net Revenue $4,000,000 Step 2: Divide net revenue of $4,000,000 by the debt service of $3,000,000 to calculate the annual debt service coverage ratio which is 1.33 to 1.
A municipal bond with an 8% coupon and eight years to maturity is purchased for 106. If the bond is sold six years later, what will be its cost basis? 100 101.50 104.50 106
101.50 When a bond is purchased at a premium (above par value), the premium must be amortized (reduced) over its life. The premium in this example is six points, which must be amortized over its 8-year life. It must be amortized 3/4 point each year (6 points divided by 8 years to maturity). After six years, it will be reduced by 4 1/2 points (3/4 x 6). Its cost basis will, therefore, be 101 1/2 (106 original cost - 4 1/2 points amortized premium).
The net borrowing cost to a municipal issuer of a Direct Pay Build America Bond (BAB) with a 7% interest rate is: 0% 2.45% 4.55% 7.00%
4.55% The Treasury will reimburse 35% of the interest payment, which results in a net borrowing cost of 4.55% (7.00% x [100% - 35%]). These bonds may be suitable for taxable, fixed-income investors. BABs allow a municipality to issue a bond with a higher interest rate, but pay an equivalent tax-free rate.
An investor who is currently in the 15% tax bracket receives a promotion that puts her in the 33% tax bracket. If an RR offers to sell her a 3.75% tax-free municipal bond, what yield would the investor need in a taxable bond to receive the same after-tax yield as the municipal bond? 2.51% 4.41% 5.60% 11.36%
5.60% If an investor in a particular tax bracket would like to compare the benefit of tax-free interest income to after-tax income of a taxable bond, it is necessary to find the equivalent taxable yield. The formula is: Municipal Bond Yield / (100% - Investor's Tax Bracket) = Equivalent Taxable Yield The customer is now in the 33% tax bracket. (The 15% rate is no longer relevant). The municipal bond has a yield of 3.75%. 3.75% (Municipal Bond Yield) / 67% (100% - 33%) = 5.60% Equivalent Taxable Yield
A corporate bond has a 12% nominal yield. To be equivalent, an investor in the 28% tax bracket would need a municipal bond with a yield of: 7.9% 8.6% 9.4% 10.2%
8.6% To determine the net yield of a taxable bond, multiply the yield by the complement of the tax bracket. The net yield is 8.6% (12% yield multiplied by 72%, which is the complement of the tax bracket).
An investor is in the 28% tax bracket. Which of the following investments affords him the BEST tax advantage? A 5% municipal bond A 5 3/4% corporate bond A 6 1/2% preferred stock A 6 3/4% convertible bond
A 5% municipal bond The 5% municipal bond offers the best tax advantage because the interest income is completely free from U.S. government taxes. The income received on the other investments is subject to U.S. taxes at the 28% tax rate. The taxable equivalent yield of the 5% municipal bond is 6.9% (5% municipal yield divided by 72%, the complement of tax bracket), which is greater than the other choices.
An investor is in the 28% tax bracket. Which of the following investments will afford him the BEST after-tax yield? A 5% municipal bond A 5 3/4% corporate bond A 6 1/2% Yankee bond A 6 3/4% convertible bond
A 5% municipal bond The 5% municipal bond will offer the best after-tax yield because the interest income is completely free from federal income taxes. The other investments are types of corporate debt subject to federal income taxes and 28% of the income received will be taxable. The taxable equivalent yield of the 5% municipal bond is 6.94%. This is calculated by dividing the 5% municipal yield by the complement of the tax bracket which is 72%. The result is greater than the other choices.
A customer has a federal tax rate of 35% and a state tax rate of 7%. Which of the following investments would afford him the BEST after-tax yield? A 6.25% in-state municipal bond A 6.25% out-of-state municipal bond A 9.95% investment-grade corporate bond A 10.25% mortgage bond
A 6.25% in-state municipal bond The major advantage of municipal bonds for most investors is that the interest received from the bond is exempt from federal taxes. In addition, most states also exempt interest from bonds issued within their state from a resident's state and local income taxes. However, if a state resident earns interest from an out-of-state municipal security, that interest is usually subject to state and local taxation. If an investor in a particular tax bracket would like to compare the benefit of tax-free interest income to after-tax income of a taxable bond, it is necessary to find the equivalent taxable yield. The mortgage bond is a type of corporate bond, therefore, choices (c) and (d) are fully taxable. Since the investor can purchase an in-state municipal bond and out-of-state municipal bond, we use the combined rate of 42% for the in-state bond and the federal rate of 35% for the out-of-state bond. The formula is: Municipal Bond Yield / (100% - Investor's Tax Bracket) = Equivalent Taxable Yield The customer is in the 42% combined tax rate. The municipal bond has a yield of 6.25%. 6.25% (Municipal Bond Yield) / 58% (100% - 42%) = 10.78% Equivalent Taxable Yield The out-of-state municipal bond has the same coupon but the equivalent taxable yield is 9.62% (6.25% / 65%). The in-state municipal bond has the best or highest after-tax yield.
A customer has a federal tax rate of 35% and a state tax rate of 7%. Which of the following investments would afford him the BEST after-tax yield? A 6.25% in-state municipal bond A 7.10% out-of-state municipal bond A 9.95% investment-grade corporate bond A 10.35% mortgage bond
A 7.10% out-of-state municipal bond The major advantage of municipal bonds for most investors is that the interest received from the bond is exempt from federal taxes. In addition, most states also exempt interest from bonds issued within their state from a resident's state and local income taxes. However, if a state resident earns interest from an out-of-state municipal security, that interest is usually subject to state and local taxation. If an investor in a particular tax bracket would like to compare the benefit of tax-free interest income to after-tax income of a taxable bond, it is necessary to find the equivalent taxable yield. The mortgage bond is a type of corporate bond and both are fully taxable. Since the investor can purchase an in-state municipal bond and out-of-state municipal bond, we use the combined rate of 42% for the in-state bond and the federal rate of 35% for the out-of-state bond. The formula is: Municipal Bond Yield / (100% - Investor's Tax Bracket) = Equivalent Taxable Yield The customer is in the 42% combined tax rate. The municipal bond has a yield of 6.25%. 6.25% (Municipal Bond Yield) / 58% (100% - 42%) = 10.78% Equivalent Taxable Yield The out-of-state municipal bond has a yield of 7.10% and the equivalent taxable yield is 10.92% (7.10% / 65%). The out-of-state municipal bond has the best or highest after-tax yield.
Which of the following orders would you place for a customer who wants to hold her auction rate security if the interest rate is set at 3.4% or higher? A hold order A limit order A bid order A sell order
A bid order A current holder of an auction rate security may indicate she wants to continue to hold the security only if the rate is set at or above a specified rate. If the clearing rate sets below the interest or dividend rate that the holder or prospective holder specifies in her bid, the holder will be required to sell the securities subject to her bid, and the prospective buyer will not acquire the securities. Auction dealers refer to bids by prospective holders as buy orders and bids by holders as roll-at-rate orders.
A woman will be retiring in 2030. She is interested in income and having her principal available at retirement. Which of the following municipal bonds would you recommend? A highly rated GO bond maturing in 2025 A highly rated GO bond maturing in 2034, which is callable in 2023 at 105 A highly rated revenue bond maturing in 2030 A non-investment-grade revenue bond maturing in 2030
A highly rated revenue bond maturing in 2030 Since the woman wants her principal available at retirement, a bond maturing in 2030 (the year of her retirement) would be the best choice. Since the revenue bond is highly rated, there is a higher probability the issuer will be able to pay off the principal at maturity compared to the non-investment-grade revenue bond.
An advertisement for municipal securities states the following: "15-year 10% tax-free bond priced to yield 12% to maturity. Call us now for more details." According to MSRB rules, this advertisement should also state that: The tax-free return is actually greater than 12% if the bond is held to maturity A portion of the yield to maturity is taxable if the bond is held to maturity, making the after-tax return between 10% and 12% The tax-free return is actually less than 10% if the bond is held to maturity A principal approved the advertisement
A portion of the yield to maturity is taxable if the bond is held to maturity, making the after-tax return between 10% and 12% According to MSRB rules, the advertisement must state that a portion of the yield to maturity for a discount bond may be subject to taxation and, therefore, does not represent a fully tax-free yield. In this question, the bond is being offered at a discount because the yield to maturity (12%) is greater than the nominal yield (coupon rate 10%). At maturity, the discount would be subject to taxation as ordinary income, causing the net yield to be between 10% and 12%.
What information would an analyst be MOST concerned with when evaluating a revenue bond? The population growth of the municipality Debt to assessed valuation A rate covenant Property taxes
A rate covenant An analyst would be most concerned with rate covenants. This is an agreement made by the municipal issuer to maintain rates high enough to cover maintenance and operating charges and to meet annual debt service requirements. The other terms are applicable to general obligation bonds.
A municipal bond issued at par is purchased at a discount and later sold at par or above. This transaction will result in: A taxable gain A tax-deductible loss A tax-free gain No gain or loss
A taxable gain If a municipal bond is purchased at a discount in the secondary market (not an original issue discount), there will be a taxable gain at maturity. A taxable gain will also result if the bond is sold prior to maturity, above the original cost.
Which of the following municipal entities would NOT issue overlapping debt? A park district A library district A school district A turnpike authority
A turnpike authority Overlapping debt involves only general obligation borrowing. A turnpike authority would typically issue only revenue bonds.
Which of the following choices is LEAST important to an investor considering a bond swap? Accrued interest Annual income Capital loss Maturity dates
Accrued interest A bond swap involves selling one bond and using the proceeds to buy another bond with either a different yield, interest rate, or maturity date. This is usually done to establish a capital loss for tax purposes. Of the choices given, the least important factor to consider in the swap or exchange is accrued interest since accrued interest paid will be included in the next interest payment and all accrued interest received has been earned prior to the bond being sold.
An investor with an investment objective of tax-exempt income will need access to the funds in four months. An RR should NOT recommend which of the following municipal securities? A variable-rate demand obligation (VRDO) An auction-rate security (ARS) A tax-anticipation note (TAN) A bond anticipation note (BAN)
An auction-rate security (ARS) A VRDO and an ARS are both long-term securities with short-term trading features. A VRDO has a put feature that permits the holder to sell the securities back to the issuer or third party. An auction rate security (ARS) does not have this feature and, if the auction fails, the investor may not have immediate access to his funds. TANs and BANs are short-term municipal notes and, if their maturities extend four months, these securities can easily be sold in the secondary market.
Which of the following approvals is required before a municipality can begin making payments on a moral obligation bond? Approval by a majority of legal age voters Approval by the state legislature Approval by the bond trustee Approval by the appropriate state agency
Approval by the state legislature
An increase in which of the following factors does NOT indicate credit conditions are deteriorating for a municipality? Bankruptcies Consumer debt Bond defaults Assessed valuations
Assessed valuations All of the items mentioned would indicate credit conditions are deteriorating for a municipality except an increase in assessed valuations. This is the value placed on property by the municipality for purposes of taxation. An increase in assessed valuations would indicate that homes within the municipality are increasing in value, which will improve the municipality's credit.
An investor buys an 8% municipal bond in the secondary market at a 10.00 basis. If the bond is held to maturity, the investor's after-tax return will be: 8% Between 8% and 10% 10% Greater than 10%
Between 8% and 10% Since the yield (10%) is higher than the coupon (8%), the bond was purchased at a discount. Since the bond was purchased in the secondary market at a discount, the interest on the bond is exempt from federal taxation but the discount will represent ordinary income at maturity. Since the investor must pay federal income tax on the ordinary income, the after-tax return will be between 8% and 10%.
The additional bonds covenant for a revenue bond is found normally in the: Official notice of sale Prospectus Bond indenture Syndicate agreement
Bond indenture All protective covenants for a revenue bond are found in the bond's indenture. Also included in the indenture are the rights and obligations of the issuer and the bondholders. The official notice of sale contains the information and procedures necessary for syndicates that wish to bid on a competitive issue of bonds. The syndicate agreement is a contract among the underwriters that defines their working relationship and addresses such items as the priority of orders and sharing of the underwriting spread. A prospectus is a disclosure document for issues that are registered under the Securities Act of 1933. Municipal revenue bonds are exempt from that Act.
Which of the following types of debt BEST defines a municipal issuer's total bonded debt? Long-term debt only Both short-term and long-term debt Both long-term and short-term debt plus overlapping debt Long-term debt plus overlapping debt
Both long-term and short-term debt plus overlapping debt Total bonded debt is the sum of both long-term and short-term debt of a municipality plus its applicable share of overlapping debt. Overlapping debt is that portion of the debt of other government units for which residents of a particular municipality are responsible, such as services or facilities shared by several municipalities.
The recommendation to purchase a private activity bond would NOT be appropriate for a: Husband and wife, both of whom have recently retired High-net-worth client who has an advisory account Client who is subject to the alternative minimum tax Client with a large portfolio of municipal bonds
Client who is subject to the alternative minimum tax A private activity bond is a type of municipal bond in which the funds being raised will be used to benefit a non-public (private) company (e.g., an airport terminal for an airline). If the person receiving the bond's interest payment is subject to the alternative minimum tax (AMT), the interest is taxable at the federal level. For this reason, these bonds are the least suitable for a client who is subject to the AMT.
If an auction for auction rate securities were to fail, the holder would: Receive the par value of the securities Continue to hold the securities and the interest rate would be set to the maximum rate Continue to hold the securities and the interest rate would be set to the minimum rate Continue to hold the securities and the interest rate would be set to a rate that cleared the auction
Continue to hold the securities and the interest rate would be set to the maximum rate A failed auction occurs when there are not enough bids to cover the amount of auction rate securities being sold. In this situation, the holders will continue to hold the securities and the interest rate will be set to the maximum rate allowed in the program documents. This rate is normally higher than the rate that would have cleared a successful auction.
A municipality's debt limit is the maximum amount of: Interest a municipality may pay out in one year Bonds a municipality may redeem in one year Debt a municipality may incur Debt that was issued based on the revenue derived from a municipal project
Debt a municipality may incur A municipality's debt limit is the maximum amount of debt a municipality may incur and is important in the credit analysis of a general obligation bond. Choice (d) would be relevant for a revenue bond.
Which of the following choices is NOT a type of overlapping debt? The issuance of debt for an adjoining road district The issuance of debt for an adjoining school district Debt issued between two counties Debt issued between two states
Debt issued between two states Debt issued between two states is not considered overlapping debt. Overlapping debt is general obligation debt of other governmental units for which residents of a particular municipality are responsible. It is the debt shared by residents of a municipality for services or facilities shared by several municipalities. Examples of overlapping debt include debt for an adjoining road district or school district, or debt issued between two counties.
Which of the following information does NOT have an effect on the credit quality of an airport revenue bond? Tourism Debt per capita Airport traffic Energy costs
Debt per capita Debt per capita is used when analyzing a general obligation bond and would not be considered for a revenue issue.
The number of times the earnings of a municipal facility exceeds the interest charges and principal payments of a revenue bond for a period is called the: Working capital ratio EBITDA ratio Debt service coverage ratio Price-earnings ratio
Debt service coverage ratio The number of times the earnings of a revenue bond of a municipal facility exceeds the interest charges and principal payments (debt service) for a period is the debt service coverage. Earnings before interest, tax, depreciation, and amortization (EBITDA) is a term associated with corporate bond issuers, not municipal bond issuers.
An airport deducts all of the following expenditures before arriving at its net revenues, EXCEPT: Runway maintenance expenses Debt service expenses Hangar expenses Salaries of airport personnel
Debt service expenses Debt service expenses are paid first only in gross revenue pledges. It is assumed that the airport is using a net revenue pledge that results in all maintenance and operation expenses being deducted before arriving at net revenues.
Buyers of municipal bonds would normally NOT include: Insurance companies Banks Defined benefit plans Mutual funds
Defined benefit plans A defined benefit plan is a type of pension fund. Pension funds and other tax-deferred accounts would not benefit from the tax exemption provided by municipal bonds. As a result, unless the bonds are taxable and offer yields equivalent to other taxable bonds, pension funds would not include municipal bonds in their portfolio. The exception would be Build America Bonds (BABs), which are taxable municipal bonds.
The City of Fremont, Nebraska is issuing revenue bonds to increase its electric power generating facilities and to replace outstanding bonds. Interest on the bonds will be: Subject to federal income tax and exempt from state taxes Subject to federal and state income tax Subject to state income tax and exempt from federal income tax Exempt from federal income tax
Exempt from federal income tax For individual investors, the interest derived from state and municipal bonds is exempt from federal income tax. The investor may need to pay state taxes, depending on the tax status of the investor's home state.
Which TWO of the following securities are considered debt obligations of municipal governments? Revenue bonds issued by the Port Authority of NY and NJ First mortgage bonds issued by a utility company Special tax bonds issued by a city agency A closed-end bond fund containing general obligation bonds I and III I and IV II and III II and IV
I and III A revenue bond and a special tax bond are both considered debt obligations of a municipal government. A special tax bond is a type of revenue bond that is backed only by a specific tax source, such as an excise tax. A mortgage bond is a type of corporate bond. Any closed-end fund that is issued by an investment company is considered a debt obligation of that investment company, not the issuer of the bonds it holds. The fact that the fund owns municipal bonds is not relevant.
In most cases, municipal bond investors may obtain which TWO of the following choices? Reduced interest-rate risk by investing in issues with different maturities A federal tax exemption by investing in private activity bonds A state and local tax exemption by investing in bonds in their state of residency A reduced risk of default by investing in bonds in their state of residency I and III I and IV II and III II and IV
I and III Municipal bond investors can obtain reduced interest-rate risk by investing in issues with different maturities. Bonds with short-term maturities will only experience a small decline in price if the general level of interest rates increases. Although most municipal bonds are exempt from federal income tax, they are not exempt from state income tax unless the owner is a resident of the state that issued the bonds, and the state elects not to tax the purchaser of the bond. The interest on municipal private activity bonds is subject to federal income tax if the investor is subject to the alternative minimum tax (AMT). The risk of default is not reduced by investing in bonds in the investor's state of residency.
An investor purchased a municipal bond at a discount. If the investor holds the bond to maturity, a gain will be considered: Tax-free interest if the bond is an OID A capital gain if the bond is an OID Ordinary income if the bond is not an OID Tax-free interest if the bond is not an OID I and III only I and IV only II and III only II and IV only
I and III only For an OID (original issue discount), the discount is considered interest. Because this is a municipal bond, the interest is tax-exempt. For a non-OID (a secondary market discount), the discount is reported as ordinary income.
Which TWO of the following statements are TRUE concerning bank-qualified municipal bonds? To qualify, the municipality may only issue up to $10,000,000 annually To qualify, the municipality must issue more than $10,000,000 annually Commercial banks are not permitted to purchase this type of security Commercial banks are permitted to purchase this type of security I and III I and IV II and III II and IV
I and IV Bank-qualified bonds are issued by small municipalities and, to qualify, a municipality may only issue up to $10,000,000 annually. This is done to encourage commercial banks to invest in locally issued municipal securities. Commercial banks that purchase this type of security are permitted to deduct 80% of the interest cost paid to depositors on the funds used to purchase the bonds.
Which TWO of the following events may be reasons for a revenue bond issue to be called? There is a change in the tax status of the issuer Surplus funds are not available Interest rates rise dramatically The facility is destroyed by fire I and III I and IV II and III II and IV
I and IV Destruction by fire would be included in a catastrophe call provision and permit the issue to be called. If surplus funds are available (choice [II] states they are not available), the monies may be used to retire a portion of the outstanding bonds. If the tax status of an issuer is in doubt at the time of issuance, there is usually a provision requiring that the issue be called if the tax status of the issuer changes and the bonds become taxable. An issuer may refund an outstanding issue if interest rates are declining, not rising.
Which TWO of the following choices would be the most suitable purchasers of municipal zero-coupon bonds? An investor who does not seek present additional cash flow An investor who seeks the tax benefits of long-term capital gains An investor who needs cash for living expenses A custodian account where the parent of the minor child is in the highest tax bracket I and III I and IV II and III II and IV
I and IV In a custodian account, the minor is technically liable for taxes. Depending on the amount of income generated in the account and the age of the minor, taxes are calculated at the parents' rate. Therefore, parents may consider the purchase of municipal bonds in the custodian account for tax advantages. The zero-coupon bond will not produce cash flow during the holding period. This would be desirable for those who do not need cash income. (Funds are needed at a later date in the custodian account.) The zero-coupon municipal bond would be suitable for other accounts besides the custodian account, such as upper tax bracket earners during their peak earning years. Zero-coupon bonds are subject to annual accretion of the investor's cost basis. As such, at maturity, the investor's cost basis equals the par value of the bond. (There are no capital gains.) The accretion of the municipal bond is treated as interest income which, in the case of the municipal bond, is federally tax-free. This is a tax advantage, but it is not a long-term capital gain.
A municipal bond swap may be executed to: Establish a loss for tax purposes Increase cash flow Improve maturities Improve yields I only I and III only I, III, and IV only I, II, III, and IV
I, II, III, and IV Municipal bond swaps may be executed to establish a loss, increase cash flow (increase income from larger coupon), improve maturities, improve yield, and improve quality.
A customer wishes to make a purchase based on his belief that interest rates will decline over the next 15 years. The recommendation of which TWO of the following securities is NOT consistent with the customer's belief? A 5-year noncallable bond A tax anticipation note (TAN) Floating rate notes A 15-year bond with a 5-year put feature I and III I and IV II and III II and IV
II and III Since the customer believes interest rates will decline, he wants to lock in a high yield for the next 15 years. A TAN is a short-term security and a floating rate note's interest rate would be adjusted downward with prevailing interest rates. Neither would lock in the high return. The 5-year noncallable bond would lock in a high return without the possibility of being called prior to maturity. The 15-year bond locks in the high return and the 5-year put feature permits the investor to redeem the bond after 5 years or keep it to maturity. This decision would depend on the prevailing rates in 5 years.
Which TWO of the following statements are TRUE concerning bank-qualified municipal bonds? To qualify, the municipality may only issue up to $10,000,000 every six months To qualify, the municipality may only issue up to $10,000,000 annually Commercial banks may receive a 70% tax deduction of the interest costs Commercial banks may receive an 80% tax deduction of the interest costs I and III I and IV II and III II and IV
II and IV
Which TWO of the following types of municipal securities does NOT require voter approval? A general obligation bond backed by income taxes A special tax bond A bond backed by ad valorem taxes A certificate of participation I and III I and IV II and III II and IV
II and IV A general obligation bond would require voter approval since it is backed by the full faith and credit of the issuing municipality. A bond backed by ad valorem or real estate taxes is a type of general obligation bond. A special tax bond is financed by a tax other than an ad valorem tax, such as a tax on cigarettes, liquor, or gasoline, and would not require voter approval. A certificate of participation (COP) is a revenue bond backed by a lease payment that does not require voter approval.
Which TWO off the following sources of income would MOST likely be used by a school district to meet its debt service for general obligation bonds that it issued? Income tax Real estate tax Sales tax Traffic fines I and III I and IV II and III II and IV
II and IV General obligation bonds are backed by the full faith, credit, and taxing power of the municipality that issues the bonds. The income to pay debt service on these bonds is derived from taxes and other general revenues. For smaller local governments, such as school districts, it would include primarily real estate taxes (also called property or ad valorem tax). In addition, traffic and other types of local fines may also be used. Income taxes and sales taxes would most likely be used to meet the debt service of larger issuers, such as states and large cities.
When analyzing the credit strength of a municipal issuer, consideration should include which TWO of the following factors? The condition of the U.S. economy The current financial status of the municipality Money supply figures The general capability of the fiscal officers of the municipality I and III I and IV II and III II and IV
II and IV The state of the local economy (not the U.S. economy) is an important factor in determining a municipality's creditworthiness. For example, communities at different stages of growth may require more or less debt and this must be understood in the analysis. The current financial status is also important to determine the credit strength of a municipality. The management capability of the fiscal officers is also important to insure they are able to implement the plans of the municipality. Money supply figures, which are published by the Federal Reserve Board are not relevant with regard to the credit strength of a municipality.
Bergen County has issued Build America Bonds to improve its transportation system. Which TWO of the following statements are TRUE concerning these bonds? The bonds are federally tax-free The bonds are federally taxable The issuer will receive a federal tax credit The issuer will receive a federal reimbursement I and III I and IV II and III II and IV
II and IV These are an example of Direct Pay Build America Bonds (BABs). BABs are a type of municipal bond that pays taxable interest but the Treasury will reimburse 35% of the interest paid on the bonds to the issuer, which reduces the cost of borrowing. This would allow municipal issuers to compete with corporate issuers when raising capital.
The four bonds listed have the same maturity. Place them in their order of yield (during most economic times), from highest to lowest. Treasury bond Investment-grade corporate bond Investment-grade municipal general obligation bond Investment-grade municipal revenue bond I, II, III, IV II, I, IV, III II, IV, III, I III, I, IV, II
II, I, IV, III A corporate bond would have the highest yield followed by Treasuries, then municipals. The municipal bond typically has the lowest yield since it is exempt from federal income tax. General obligation bonds are generally considered safer than revenue bonds and, therefore, carry a lower yield. The corporate bond is of lower quality than the Treasury bond (a U.S. government obligation) and will, therefore, have a higher yield.
A customer is most interested in safety of principal and wishes to avoid risk. List the securities you would recommend to the customer from those with the LEAST risk to those with the MOST risk. General obligation bonds Treasury notes Treasury bills Revenue bonds III, I, II, and IV II, III, I, and IV III, II, I, and IV I, IV, III, and II
III, II, I, and IV
The provisions for the flow of funds of a revenue bond issue appear in the: Syndicate letter Account summary statement Notice of sale Indenture
Indenture The indenture contains all the agreements and covenants pertaining to a bond issue, and also contains the provisions for the application and allocation of funds of a revenue bond.
If an investor was primarily interested in safety of principal, which of the following securities would you LEAST likely recommend? State GO bond GNMA security Railroad equipment trust bond Industrial development revenue bond
Industrial development revenue bond Industrial development revenue bonds are secured by a lease agreement with a corporation and are only as secure as the corporation. State GOs are generally of high quality and a GNMA is secured by the U.S. government. The holder of an equipment trust bond has a lien on the equipment that secures the issue.
Which of the following statements is TRUE about revenue bonds? a. Interest is usually paid from the earnings of the facility for which the bond was issued b. Interest is subject to federal taxes c. Revenue bonds are considered safer than general obligation bonds d. The state public utility commission must approve each interest payment
Interest is usually paid from the earnings of the facility for which the bond was issued The interest on a revenue bond is usually paid from the earnings of the facility for which the bonds were issued. The interest is exempt from federal income tax and revenue bonds are considered riskier than general obligation bonds. State public utility commissions set utility rates within the state but they do not approve municipal revenue issue payments.
Municipal notes are used for: Interim financing Long-term financing Taxable financing Permanent financing
Interim financing
All of the following factors are of importance with regard to debt structure when analyzing a municipal bond, EXCEPT: Total bonded debt Total direct debt Overlapping debt Matured debt
Matured debt Matured debt is debt of the municipality that is no longer outstanding and, therefore, is not included in analyzing the debt structure of a municipal bond. Total bonded debt is all of the general obligation debt issued by a municipality, regardless of its purpose. Total direct debt is the sum of the total debt and any unfunded debt (i.e., short-term notes) of a municipality. Overlapping debt is that portion of the debt of other government units for which residents of a particular municipality are responsible, such as services or facilities shared by several municipalities.
A project financed through revenue bonds is experiencing difficulty in that revenues are not sufficient to meet debt service payments. If, through legislative approval, the state pays interest and principal in a timely manner, the issue is most likely: Double-barreled bonds Moral obligation bonds Bond anticipation notes Limited tax bonds
Moral obligation bonds Moral obligation bonds are municipal revenue bonds that are payable by the state if revenues from the project do not satisfy debt service payments. However, in order for the state to service the debt, approval of the state legislature is required. Double-barreled bonds are issued as general obligations backed by the full faith and credit of the issuing municipality.
A municipality may issue a Direct Pay Build America Bond to finance all of the following activities, EXCEPT to: Refund a mass transportation bond Raise capital to expand its school system Make a primary offering to establish a public sewer system Raise additional capital for a government housing project
Refund a mass transportation bond A Direct Pay Build America Bond may be used to raise capital for the same purposes as regular tax-exempt municipal debt, except for refundings, working capital, and private activity bonds.
Money put aside on a municipal revenue issue for the betterment and improvement of the facility is placed in the: Sinking fund Renewal and replacement fund Operating and maintenance fund Debt service fund
Renewal and replacement fund
A double-barreled municipal bond is backed by the: Revenues of a project Taxes of a municipality Revenues of a project and taxes of a municipality Revenues of the U.S. government
Revenues of a project and taxes of a municipality A double-barreled municipal bond is backed by two sources of income, which would be the revenues of a project and the taxes of a municipality.
Which of the following choices is Standard and Poor's (S&P's) best rating for a municipal note? SP-1 SP-3 Aaa AAA
SP-1 Standard and Poor's best rating for notes is SP-1 and its worst rating is SP-3. AAA is S&P's best rating for bonds.
Interest received from which of the following securities may be taxable at the state and local level? U.S. government Federal Home Loan Bank Commonwealth of Puerto Rico State of Hawaii
State of Hawaii
A bond swap is done for all of the following reasons, EXCEPT to: Increase the overall yield of the bond portfolio Increase the current income of a bond portfolio Establish a tax loss to offset income Take advantage of a large amount of accrued interest
Take advantage of a large amount of accrued interest
An investor must pay accrued interest for a secondary market purchase of: Zero-coupon bonds Series EE savings bonds Tax anticipation notes Treasury bills
Tax anticipation notes Zero-coupon bonds and Treasury bills are original issue discount securities and trade without accrued interest. While Series EE bonds are also OID securities, they do not trade in the secondary market. Tax anticipation notes (TANs) are typically interest-bearing securities and trade with accrued interest.
To determine what would happen to the coverage of revenue bonds when more bonds are going to be issued in the future, one should examine: The rate covenants of the bond Feasibility studies The refunding procedure of the bond The additional bonds test
The additional bonds test The additional bonds test sets a minimum level of coverage of debt service for interest and principal for all outstanding bonds and for future debt. The additional bonds test protects original bondholders against the dilution of the debt service coverage. Rate covenants insure that rates will increase in line with costs to insure proper revenues for the maintenance of the facility or project and payment of the debt service. Feasibility studies are conducted to insure the proper need of the project being developed. Refunding is used to lower interest expense on bonds through the issuance of new bonds at lower coupon rates. The proceeds of the new bond sale would be used to repurchase the already outstanding high-coupon bonds.
Industrial development revenue bonds are backed by: The local municipal district in which the facility is domiciled The state in which the facility is domiciled The corporate guarantor Both the corporate guarantor and municipality
The corporate guarantor
A broker-dealer has two municipal bonds in its inventory. One is a non-AMT bond that yields 4.50% and the other is an AMT bond that yields 4.85%. Which of the following statements is TRUE of a recommendation that is made to a client who is subject to the AMT and is in the 28% tax bracket? The non-AMT bond is a better recommendation Both bonds offer the same after-tax return The AMT bond is a better recommendation Municipal bonds are not suitable for the client
The non-AMT bond is a better recommendation If the person receiving the bond's interest payments is subject to the alternative minimum tax (AMT), the interest is taxable at the federal level. The after-tax yield on the AMT bond is 3.49% (4.85% x [1.00 - 28%]), while the after-tax yield on the non-AMT bond is 4.50%. Ultimately, these types of bonds are unsuitable for an investor who is subject to the AMT.
Which of the following factors would be LEAST useful when analyzing the credit risk of an issuer of revenue bonds? Engineering reports The ratio of the amount of net overall debt to assessed valuation Debt service coverage ratio Special taxes
The ratio of the amount of net overall debt to assessed valuation The ratio of the amount of net overall debt (both direct and overlapping) to assessed value is useful in analyzing the credit risk of an issuer of general obligation bonds. A special tax bond is a type of revenue bond and, therefore, the amount of special taxes may be useful in analyzing the credit risk of an issuer of a revenue bond.
Rockland County has issued industrial development revenue bonds for the benefit of the Hudson Nail and Screw Co. In evaluating the credit quality of these bonds, an investor should look primarily at: The tax collection ratio of Rockland County The general credit of Rockland County The revenue stream of Hudson Nail and Screw that will be committed to meet the lease payment obligation to Rockland County The yield differential between Rockland County Revenue bonds and Hudson Nail and Screw unsubordinated debentures
The revenue stream of Hudson Nail and Screw that will be committed to meet the lease payment obligation to Rockland County The security backing the industrial development revenue bond is the lease payment made by the corporation. An investor must assess whether Hudson Nail and Screw can meet this obligation by generating sufficient revenues from its primary business
All of the following statements are TRUE concerning both auction rate securities (ARSs) and variable-rate demand obligations (VRDOs), EXCEPT: Interest rates are set at specified intervals They are often issued by municipalities They are long-term securities with short-term trading features They have a put feature allowing the holder to redeem the security at par
They have a put feature allowing the holder to redeem the security at par Although they are both long-term securities with short-term trading features, only VRDOs have a put feature that permits the holder to sell the securities back to the issuer or third party. Auction rate securities (ARSs) do not have this feature and, if the auction fails, the investor may not have immediate access to her funds. In addition, ARSs use an auction process to reset the interest rate on the securities, whereas the interest rate on a VRDO is reset by the dealer at a rate that allows the securities to be sold at par value.
A municipality issues a bond backed by revenue from a project. If the municipality also has bonds outstanding that have the same claim against revenue, which of the following statements is TRUE? This is a double-barreled bond This is a parity bond This type of bond requires voter approval This type of bond would be taxable if the investor was subject to the alternative minimum tax
This is a parity bond This is an example of a parity bond where two or more issues of revenue bonds have the same claim against revenue or are backed by the same pledged revenues. A double-barreled bond is backed by a source of revenue and the full faith and credit of an issuer that has taxing power, i.e., a general obligation (GO) bond issuer. General obligation bonds, not revenue bonds, require voter approval. Only the interest received from certain municipal private activity bonds is taxable if an investor is subject to the alternative minimum tax.
The federal tax exemption for interest earned on an industrial revenue bond is NOT available if the: a. Holder of the bond is a substantial user of the facility b. Issuer does not subscribe to equal opportunity employer standards c. Bonds are not approved by the MSRB d. Underwriter has a control relationship with the issuer
a. Holder of the bond is a substantial user of the facility
A customer owns a municipal bond that has been escrowed to maturity. Which of the following statements is TRUE? a. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds at maturity b. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds prior to maturity c. The issuer has deposited money in an escrow account that will contain other municipal bonds used to pay off the municipal bonds at maturity d. The issuer has deposited money in an escrow account containing U.S. government securities that will create a tax liability for the municipal bondholder at maturity
a. The issuer has deposited money in an escrow account that will contain U.S. government securities used to pay off the municipal bonds at maturity When interest rates fall, a municipality may want to engage in advance refunding. In this case, the municipality will sell a new issue with the proceeds of the sale going into an escrow account containing U.S. government securities. Since the municipal bond has been escrowed to maturity, the U.S. government securities would be purchased with a maturity date that coincides with the maturity date of the municipal bonds.
Which of the following statements is TRUE concerning the tax treatment of municipal bonds? a. If the bond was purchased at a premium, it will be accreted based on the constant yield method b. If the bond was purchased as an original issue discount (OID), the discount will be accreted based on a constant yield method c. The premium will not be amortized if the bond was purchased at a premium d. The discount will be amortized if the bond was purchased as an original issue discount (OID)
b. If the bond was purchased as an original issue discount (OID), the discount will be accreted based on a constant yield method A municipal bond purchased as an original issue discount (OID) is accreted (not amortized) each year for tax purposes based on a constant yield method (also called constant interest method), which uses the bond's yield to maturity. Municipal bonds purchased at a premium are amortized (not accreted) each year based on a constant yield method.
Treasury arbitrage restrictions generally prohibit issuers of municipal securities from: a. Selling municipal securities with coupon rates that are lower than Treasury securities b. Selling municipal securities with coupon rates that are higher than Treasury securities c. Investing bond proceeds in higher-yielding Treasury securities d. Investing bond proceeds in lower-yielding Treasury securities
c. Investing bond proceeds in higher-yielding Treasury securities Because of the tax exemption allowed on municipal bond interest, municipalities are normally able to issue bonds with coupon rates below those of Treasury securities. This presents an excellent arbitrage opportunity. A municipality can borrow at a low rate of interest and invest the money in higher-yielding risk-free Treasury securities. Congress has enacted laws, known as Treasury arbitrage restrictions, that prevent state and local governments from misusing the tax exemption.
Which of the following descriptions best defines a tax swap? a. The purchase and sale of bonds to incur commissions b. The exchange of convertible bonds for stock to avoid the receipt of taxable interest income c. The purchase and sale of bonds to realize a capital loss to offset against a capital gain for tax purposes d. Exercising the exchange privilege of a mutual fund
c. The purchase and sale of bonds to realize a capital loss to offset against a capital gain for tax purposes
When analyzing a general obligation bond, which of the following factors is NOT a positive indicator of the bond's quality? a. Voter registrations have increased over the last 18 months b. The department of motor vehicles reports that out-of-state drivers have been registering their cars in your state at an increasing rate c. The state increased the toll for the use of the turnpike d. A multiplex cinema, do-it-yourself store, and book-selling chain have all announced new franchises in your community
c. The state increased the toll for the use of the turnpike An increasing population trend and a mixture of diverse businesses (both new and established) are positive demographic indicators that reinforce the quality of general obligation issues. User fees are generally associated with revenue bond issuers.
All of the following statements are TRUE concerning private activity bonds, EXCEPT: a. The interest on these bonds might not be tax-exempt for some investors b. The interest on these bonds might be subject to the alternative minimum tax c. The possibility that the bonds might be subject to taxation would be reflected in the yield at which the bond trades d. These types of municipal bonds are generally GOs
d. These types of municipal bonds are generally GOs Private activity bonds are issued to finance the construction of a facility that will be used by a private corporation. Interest earned on such bonds is often subject to the Alternative Minimum Tax (AMT). The AMT is a second method of calculating federal income tax liability. Taxpayers must pay the larger of the AMT or the result of the regular (Form 1040) income tax calculation. In theory, this is true for all taxpayers but, in reality, the AMT is only an issue for higher income taxpayers or those with special tax preference items on their returns. When calculating the alternative minimum tax, certain items may need to be included in taxable income that normally are not. One of these items is the interest on many private activity bonds. Therefore, a taxpayer subject to the AMT may lose the tax exemption on these bonds. Since this is a disadvantage, these bonds generally trade with higher yields than regular municipal bonds to reflect that the interest received might be taxable. Choice (d) is correct because private activity bonds are generally revenue bonds, not general obligation bonds.
