Unit 6
A customer in the 28% tax bracket wants to buy a municipal GO bond with a 7.5% yield that matures in 6 years. The tax-equivalent yield of this bond is
0.104. To calculate the taxable return, use the tax-free equivalent yield formula: municipal bond yield ÷ (1 − investor's tax bracket). Using this formula, 0.075 ÷ (1 - 0.28) = 0.104, or 10.4%. This means the investor, who is in the 28% tax bracket, must earn 10.4% in taxable interest to equal the 7.5% tax-free municipal interest yield.
A customer has realized a capital gain from the sale of a municipal bond. To reduce her tax liability, the capital gain can be offset against a capital loss in which of the following investments? 1. General obligations 2. Equity securities 3. Corporate bonds 4. Collateralized mortgage obligation
1, 2, 3, & 4 Any capital loss will offset a capital gain.
Your customer, a small-business owner, likes investments that are short term, relatively safe from credit risk, and liquid. He's heard that higher rates of return can be realized from auction rate securities than the rates he is currently getting on the Treasury bills in his portfolio. He asks you to explain them to him. Which of the following would you note as being reasons why they are not suitable for him? 1. Auction rate securities are intended as long-term investments. 2. Interest or dividend rates are reset at established intervals based on a Dutch auction. 3. If the auction fails, holders of ARSs may not have immediate access to their funds. 4. The interest or dividend rate is set as the lowest rate to match supply and demand at the time of the auction.
1. Auction rate securities are intended as long-term investments. 3. If the auction fails, holders of ARSs may not have immediate access to their funds.
Which of the following would not be examples of overlapping debt? 1. Debt to build a state office building within city limits 2. Debt to maintain a county park district serving a municipality 3. Debt backed by two states cooperating in the construction of a bridge 4. Debt for a high school district within city limits
1. Debt to build a state office building within city limits 3. Debt backed by two states cooperating in the construction of a bridge
If an investor were to purchase a bond in the secondary market several years after the public offering, which of the following would factor in calculating the total dollar amount paid for the bond? 1. Settlement date 2. Dated date 3. Coupon 4. Scale
1. Settlement date 3. Coupon
A customer purchases a municipal bond in the secondary market with a settlement date of August 1. If the next interest payment is September 1, which of the following statements regarding interest on this bond are true? 1. The bond pays interest on March 1 and September 1 each year. 2. The seller must pay accrued interest no later than settlement day. 3. Accrued interest on this bond is computed using actual days elapsed. 4. On September 1, the buyer will receive from the issuer interest for the period March 1 through August 31.
1. The bond pays interest on March 1 and September 1 each year. 4. On September 1, the buyer will receive from the issuer interest for the period March 1 through August 31.
Which of the following statements regarding municipal revenue bond issues are generally true? 1. The bonds' feasibility is dependent on the earnings potential of the facility or project. 2. The bonds are backed by unlimited taxing power of the issuer. 3. User fees provide revenue for bondholders. 4. Revenue bonds are most suitable for investors with high risk tolerance.
1. The bonds' feasibility is dependent on the earnings potential of the facility or project. 3. User fees provide revenue for bondholders.
Which of the following statements regarding the suitability of municipal bonds are true? 1. The tax-free interest payments make them more suitable for those in higher tax brackets. 2. The tax-free interest payments make them more suitable for those in lower tax brackets. 3. The tax-free interest is why municipal bonds are not considered suitable investments to be included in one's retirement account, such as an IRA. 4. The tax-free interest is one reason why municipal bonds are considered suitable investments to be included in one's retirement account, such as an IRA.
1. The tax-free interest payments make them more suitable for those in higher tax brackets. 3. The tax-free interest is why municipal bonds are not considered suitable investments to be included in one's retirement account, such as an IRA
The Interstate Bridge Authority has an outstanding revenue bond. For the most recent operating period, the Authority has net revenue of $36 million, operations and maintenance expenses of $16 million, debt service requirements of $18 million, and surplus funds of $2 million. The debt service coverage ratio for the Interstate Bridge Authority's revenue bond is
2:1. The debt service coverage ratio is determined by dividing the net revenue by the debt service requirement. the debt service coverage ratio would be 2:1 ($36 million divided by $18 million = 2). If you subtracted the $16 million of expenses because you did not notice that we gave you the net revenue, your ratio was 20 divided by 18 = 1.11 to
Voter approval may be required for new bond issues for construction of which of the following? 1. Airports 2. Turnpikes 3. State prisons 4. Public high schools
3. State prisons 4. Public high schools
A legal opinion issued for a municipal bond covers which of the following? 1. Feasibility of public works projects 2. Creditworthiness of the issuing municipality 3. Tax status of the municipal debt 4. Constitutionality and legality of the municipal debt
3. Tax status of the municipal debt 4. Constitutionality and legality of the municipal debt
One of your customers is in the 37% federal income tax bracket. The customer prefers purchasing corporate bonds over municipal bonds because the corporation's financials are much easier to understand. On the customer's next purchase, the instructions are to find a corporate bond that will yield the same after-tax return as would be received from a municipal bond with a 3.20 coupon. The bond you suggest must have a coupon of
5.08%. This is a tax-equivalent yield question. The interest paid on a corporate bond is taxable, while that of the municipal bond is tax free. The formula is: The coupon of the municipal bond divided by (100% − tax bracket). In our question, that would be 3.20% divided by 63%, or 5.08%
Which of the following bodies may not incur overlapping debt?
A state government Overlapping debt is debt of another issuing body that is paid by property taxes of residents. School districts, parks and recreation departments, highway departments, and library systems are all paid through real estate taxes (GOs). State debt is least likely to be overlapping, as states do not generally tax real estate.
A customer buys a municipal bond regular way on Tuesday, December 23. The transaction will settle on the following
Friday Municipal bonds, like corporate bonds, settle two business days after the trade date. December 25 (Christmas) is not a business day
Which of the following types of municipal bonds is subject to statutory debt limits?
General obligation (GO) bonds Only GO bonds, which are backed by the taxing authority of the issuer, are subject to statutory debt limits.
The interest from which of the following bonds might be included in the alternative minimum tax calculation?
Industrial revenue bonds, sometimes called industrial development bonds, may be nonpublic purpose bonds, and the proceeds are used to benefit private corporations. As such, the interest income from these bonds is a tax preference item in the alternative minimum tax calculation
Which of the following statements regarding revenue bonds issued by a state or municipality is true?
Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve. Because revenue bonds are not backed by the full faith and credit of the municipality that issues them, the earnings of the revenue-producing project must be large enough to cover the interest and principal payments.
Which of the following statements regarding a bond trading flat is not true?
It may be traded with accrued interest. A municipal or corporate bond trading flat is trading without accrued interest. The bond may be an income bond, which normally pays no interest, or it may be a bond currently paying no interest because it is in default.
Which of the following are directly backed by the U.S. government?
PHAs and NHAs Public Housing Authority and New Housing Authority issues are unique as municipal instruments because they are fully backed by the U.S. government.
The interest on which of the following municipal securities may be considered preference income for alternative minimum tax purposes?
Private purpose bonds Interest on private activity municipal bonds is included in the taxable income of an investor who is subject to the alternative minimum tax.
Which of the following bonds is issued to finance the construction of subsidized housing and is backed by rents and the taxing authority of the U.S. government?
Section 8 Section 8 bonds, also known as Public Housing Authority bonds and New Housing Authority bonds, are used to finance subsidized housing
Who has the final responsibility for debt service on an industrial revenue bond?
The corporation leasing the facility
Which of the following statements describing Section 529 plans is true?
The maximum lifetime contribution varies from state to state.
While acting in a financial advisory capacity to a municipal issuer, a municipal securities dealer wants to be part of a syndicate in the underwriting of one of the issuer's new bonds. Which of the following statements regarding this situation is true?
This is recognized by the MSRB as a potential conflict of interest; municipal rules generally prohibit a broker-dealer from acting in both capacities.
An investor purchased 10 GO bonds at a discount of 2 points per bond. The bonds mature in 10 years. After holding the bonds for 5 years, they were sold at par. For tax purposes, the investor has
a $100 gain. The cost per bond is $980. The accretion amount each year is $20. $20 ÷ 10 years = $2 per year. $2 per year × 5 years = $10 per bond accretion, making the adjusted cost basis $990 per bond. When the bonds are sold at par ($1,000), there is a profit of $10 per bond × 10 bonds, which equals a $100 gain.
The computation for accrued interest on corporate and municipal debt obligations is based on
a 30-day month and a 360-day year.
An investor who wants a long-term tax-free bond with the highest possible safety should invest in
a New Housing Authority bond
An investor receiving a quote of 102 for a municipal security is probably interested in
a term bond. A quote of 102 is referred to as a dollar quote ($1,020) rather than a yield quote. The most common dollar bonds are those with a term maturity. The other choices are most often quoted on a yield basis rather than a price basis.
A municipal finance professional (MFP) is
an associate of a broker-dealer engaged in municipal securities representative activities other than retail sales.
All of the following would be indications of a deteriorating credit situation except
an increase in municipal assessed valuations.
An investor buys a municipal bond at a discount. The bond carries a 3% coupon. At maturity, the bond will pay the face amount to the holder of the bond on the maturity date. In the meantime, the IRS requires accretion of the discount. That accretion is tax-exempt income when the bond is
an original issue discount bond.
An example of overlapping debt would be a school district and
county general debt Do not combine revenue bonds with GOs to determine overlapping debt. Overlapping debt occurs in real estate taxing situations. Only GOs are backed by real estate taxes
All of the following municipal bonds would be defined as revenue bonds except A) general obligation bonds. B) special tax bonds. C) new housing authority bonds. D) special assessment bonds.
general obligation bonds.
A municipal securities principal must approve all of the following except
legal opinions.
If a municipal bond has a call provision, this will tend to
make the bond less attractive to investors because a call would terminate the interest payments.
All of the following terms are associated with general obligation (GO) bonds except
protective covenants. The protective covenants are found in the trust indenture of a revenue bond
Several years ago, one of your customers bought an original issue discount (OID) municipal bond at $960. The bond has now matured. For federal income tax purposes, the discount is
tax free. When buying an OID municipal bond, the discount must be accreted each year and treated as interest income. Because interest income from a municipal bond is tax free at the federal level, the discount is not taxed if the bond is held to maturity. If the customer had purchased a discount in the secondary market, the discount would have been accreted and taxed as ordinary income.
All of the following regarding Section 529 education savings plans are true except A) there are high contribution limits. B) withdrawals at the federal level for qualified education expenses are tax free. C) they are not subject to income limitations. D) tax-deductible contributions are at the federal level.
tax-deductible contributions are at the federal level.
All of the following municipal securities are quoted on a yield basis except
term bonds. Term bonds, or dollar bonds, are quoted like corporate bonds as a percentage of par. All other municipals are quoted in basis.
After an extensive feasibility study on the viability of a new shopping mall, the City of Mount Vernon decided to issue bonds that depend on the earning requirements of the facilities. All of the following statements are true except
that the bonds are backed by the full faith and credit of the City of Mount Vernon.
All of the following would be found in a bond resolution for a new municipal issue except A) the issuer's obligations to bondholders. B) covenants to which the issuer must adhere. C) a description of the issue. D) the costs to be incurred by the issuer in connection with the offering.
the costs to be incurred by the issuer in connection with the offering.
All of the following would be found in a bond resolution for a new municipal issue except
the costs to be incurred by the issuer in connection with the offering. The bond resolution (or the bond contract) spells out the characteristics of the issue (maturities, call features, etc.), the issuer's responsibilities to bondholders, and any restrictive covenants to which the issuer must adhere
When creating a diversified municipal bond portfolio, all of the following should be considered except A) the geographic location of the issuer. B) the credit rating. C) the denomination of the bonds included in the portfolio. D) the source of funds backing the bonds.
the denomination of the bonds included in the portfolio.
A city has issued bonds to construct a new sewage treatment facility. If the bonds are not backed by the full taxing authority of the city, all of the following statements about the bond issue are true except
the disbursement of principal and interest payments must be approved semiannually by the state public service commission.
A moral obligation bond is one where
the governing legislature is empowered, but not obligated to appropriate funds to prevent the bond from going into default.
The Municipal Securities Rulemaking Board (MSRB) is authorized to adopt rules concerning all of the following except
the information to be provided by municipal issuers.
The bond resolution includes all covenants between
the issuer and the trustee acting for the bondholders.
