* ch. 2 municipal debt - quiz
To smooth out cash flow, a municipality will issue all of the following EXCEPT:
BAN Municipalities issue BANs (Bond Anticipation Notes) to "pull forward" funds that will be collected from a later permanent bond sale. These are isolated events, since municipalities do not sell bonds every day (unlike collecting taxes and revenues). For example, a municipality expects to float a 20 year bond issue in 6 months. It can get the funds today by issuing 6 month BANs now. When the bond issue is floated, the proceeds are used to pay off the BANs. ban is a short-term municipal security issued as a source of interim financing when a long term bond is about to be issued. The proceeds from the issuance of the bonds will be used to retire the BAN. This security typically matures in less than one year and there are no periodic interest payments during this period. The payment at maturity consists of both the repayment of the principal and the interest earned over the life of the security. (compare Construction loan note (CLN), Grant anticipation note (GAN), Revenue anticipation note (RAN), Tax anticipation note (TAN), Tax and revenue anticipation note (TRAN)) A BAN is a Bond Anticipation Note - a short term note that will be retired by a later long term bond sale.
A municipality is at its debt limit and wishes to sell additional bonds. Voter approval would NOT be required for the municipality to sell:
Bonds to construct a for-profit sports facility Voter approval is needed for a municipality to sell general obligation (G.O.) bonds (non-self supporting debt) in an amount that exceeds the municipality's constitutional limit. It makes no difference if the general obligation bonds are backed by limited or unlimited taxing power. Bonds used to construct schools would be G.O. issues. 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. The stadium bonds would be self supporting.
Which statement is TRUE about a Certificate of Participation (COP)?
COPs are considered to be backed by a revenue pledge and payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds As municipalities reached their debt limits with G.O. bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states. A COP is issued by a state entity where lease revenues are pledged to back the issue. The lease payments are received from a project such as a university dormitory, prison, municipal office building, municipal transit system, etc. The "difference" is that the lease payment is made based on the governing body making an annual appropriation from tax collections, and it is not "legally" obligated to do so, hence it is not really a bond. Rather, it is a security that gives the holder a share of "revenue" if the appropriation is made (which it will be, otherwise that issuer's credit rating would be trashed). COP issuance has increased greatly over the years because they are easier to issue than G.O. debt (no pesky debt limits or voter approval to deal with) - but they are sold at a slightly higher yield, because they have more credit risk.
From an issuer's standpoint, as the years progress, "level debt service" serial bond issues have:
Decreasing interest payment amounts and 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.
What would be evaluated in the feasibility study prepared prior to the issuance of revenue bonds?
Expected operating costs of the facility The feasibility study performed prior to the issuance of revenue bonds is an economic study that projects revenues and costs for the facility to determine if there will be sufficient net revenues to service the debt. The effect of any competing facilities is included in the study. This is basically an economic analysis of the project. Legal aspects, such as the trust indenture, enabling legislation and tax statutes, are not included in the feasibility study. These are evaluated by the bond counsel.
A municipal "GAN" could be backed by all of the following EXCEPT:
Federal tax collection monies A municipal "GAN" is a Grant Anticipation Note. These are used by municipalities to "pull forward" federal grant monies that are received to support mass transit improvements in cities, pollution control facilities and energy conservation infrastructure.
Which of the following revenue bond issues would likely pledge the earnings from invested endowment funds to the bondholders?
Hospital bond Hospitals and colleges are often given large monetary gifts - known as "endowments." The institution invests the endowment funds to generate interest and dividend income. It usually agrees not to invade the principal amount. The earnings on the endowment funds are a source of revenue that can be pledged to bondholders under a revenue pledge.
The manager of a pension plan would most likely invest in all of the following debt issues EXCEPT:
Municipal Bonds Pension plans are "tax qualified" retirement plans. Earnings on securities held are tax deferred; so there is no benefit to investing in municipals, which have lower interest rates because their interest income is exempt from Federal income tax. Investments would be made in corporate and government bonds, both of which have higher interest rates because their interest income is taxable by the Federal government.
Which statement is TRUE regarding debt obligations?
Municipalities issue revenue 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-not the full faith and credit of the issuer.
A political subdivision wishes to issue a bond backed by taxes on cigarettes and gasoline. It would most likely issue a(n):
Special tax bond A municipal bond which is secured by taxes other than ad valorem taxes is a special tax bond. These "special taxes" are typically excise taxes on tobacco, alcohol and gasoline. NOT SPECIAL ASSESSMENT. Ad valorem taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales, business or income taxes)
During its fiscal year, New York state is experiencing a temporary cash flow shortage, expected to last for 5 months. To meet current obligations, the state would most likely issue:
TANs To ease a temporary cash flow shortage, municipalities will issue either TANs (Tax Anticipation Notes) or RANs (Revenue Anticipation Notes). These notes are paid off when the taxes or anticipated revenues are collected sometime in the near future. Long term bond issues are not appropriate to meet cash flow shortages and CLNs (Construction Loan Notes) are only issued in connection with building projects.
All of the following statements are true regarding Construction Loan Notes ("CLNs") EXCEPT:
When the facility is completed, the permanent financing is added to the outstanding balance ("basis") of the CLNs Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing). CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 2 to 3 years, to coincide with the projected construction period of the building. Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year. The first statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.
A municipality would use general obligation bonds to finance all of the following EXCEPT the:
construction of an industrial park The proceeds of general obligation bonds are used by municipalities to provide services to the general population - including the building and improvement of schools, police and fire department structures, and general municipal buildings. These bonds are serviced from general tax collections. Revenue bonds are used where there is a specific revenue source that can be pledged to bondholders to service the debt. Toll roads; toll bridges and tunnels; industrial parks where rents paid are the revenue source; water and sewer systems where separate water and sewer charges are imposed; are all typically built with revenue bond issues.
Significant investment features for the purchaser of municipal bonds include all of the following EXCEPT:
interest is currently state and local tax exempt Interest income derived from municipal bonds is currently exempt from federal income tax; however it is subject to state and local tax unless the state exempts the issue from taxation. Most states allow this only for issues that are purchased by residents of that state.
Municipal variable rate demand notes have a:
minimum value which will never go below par and are not subject to market risk Municipal variable rate demand notes are issued by a municipality. The interest rate is reset to the market rate weekly; and at the reset date, the holder can "put" the bonds back to the issuer at par. Here, the minimum value of the bond is par - because of the put feature. Because the price of the bond cannot go below par, these bonds are not subject to market risk. However, if interest rates fall, the price can go above par (by a small amount) until the next reset date.
Construction Loan Notes are repaid from:
monies received from a permanent take-out financing Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing).
Which of the following is FALSE? Municipal bond traders execute transactions:
on the floor of recognized exchanges Municipal bonds are traded in the over-the-counter market. They are not traded on national stock exchanges. Remember, there is no national trading market in municipals - a requirement for listing - so municipal markets are generally confined to the state of issuance. Bonds can be traded in the OTC market with bank dealers, other brokers, as well as with municipal broker's brokers. These are wholesale firms (of which only 12 exist in the U.S.) that only trade with retail municipal brokers. These firms do not take inventory positions. They act as an agent, usually helping the retail firm with large institutional trades.
Municipalities would issue tax exempt commercial paper for all of the following reasons EXCEPT to:
refund an outstanding bond issue Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a bond anticipation note). Commercial paper cannot be used for long term financing such as a bond refunding.
Trades of municipal bonds settle "regular way" the:
second business day after trade date Trades of municipal securities settle "regular way" 2 business days after trade date.
A municipal bond which funds an improvement that benefits only a small portion of the community is a:
special assessment bond Special assessment bonds are used to fund an improvement which benefits only a small portion of the community. For example: new street lights are installed in a specific area where only that area is assessed higher taxes to pay for the improvement.
A "qualified" legal opinion on a revenue bond is one which:
states that the pledged revenues are subject to prior liens A qualified legal opinion is one where the bond counsel has found a legal or tax "problem," and the counsel details the "qualification" in the opinion. For a revenue bond issue, a reason for a qualified opinion is that the bond counsel has found other legal claims (liens) on the revenues that have been pledged to the bondholders.
BABs are:
subject to Federal income tax "BABs" are Build America Bonds. Build America Bonds were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the debt market for needed capital projects. The proceeds of BABs cannot be used to prerefund existing issues (that does not create jobs).
A double barreled bond is one backed by a pledged source of revenue, as well as:
the pledge of the municipality's ad valorem taxing power 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.
Short sales of municipal bonds rarely occur because:
the trading market is thin, making short covering difficult Municipal bonds are usually not sold short because the trading market is very limited. Unlike corporate securities and government securities which receive no special tax status, municipal bonds are typically exempt from state and local tax if purchased by a resident of that state (in addition to the federal tax exemption). Thus, trading of municipal issues is typically confined to the state in which it was issued: there is no national trading market. Shorting a security requires the trader to buy back (and therefore replace) the exact security that was sold. This is difficult to do if there are few bonds trading at any one time. Another important reason why muni's are not shorted is because most issues are serial bonds. Serial bonds mature over a sequence of years. Thus, if a bond maturing in the year 2030 is shorted, it must be replaced with a 2030 bond. Out of the total issue, there may have been very few 2030 bonds, further limiting the potential trading market.
Revenue Anticipation Notes are a(n):
unfunded debt that is a source of temporary financing A Revenue Anticipation Note (RAN) is issued by a municipality that wishes to borrow short-term against revenues that are expected to be received in the near future. Thus, this is a source of temporary financing and it is an unfunded (short term) debt.
