Series 7 Chapter 6
A customer purchases an XYZ municipal bond at 108. It is scheduled to mature in 16 years. After owning the bond for 10 years, he sells the bond at 102. What capital gain or loss must he report for tax purposes at the time of the sale?
$10 loss If a municipal bond is purchased at a premium, the premium must be amortized over the time until maturity. An $80 premium on a 16-year municipal bond indicates that $5 will be amortized each year ($80 divided by 16 = $5). Ten years at $5 per year is $50 of amortization. Therefore, after 10 years, the tax basis would be $1,080 minus $50, or $1,030 (103). Because the sale was for 102 ($1,020), the customer has a $10 loss on one bond.
If an individual fails a FINRA qualification exam three consecutive times, a fourth attempt may NOT be made for:
180 days
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?
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.
A broker's broker does all of the following EXCEPT:
A broker's broker acts as agent in transactions by facilitating the movement of blocks of bonds. The broker's broker is allowed to conceal the identities of the contra-parties, thus protecting investment strategies. A broker's broker does not make a market in securities.
Advertising relating to municipal securities must be approved by which of the following?
According to MSRB rules, advertising (communications with the public) must be approved by either a municipal securities principal or a general securities principal.
Which of the following does the MSRB require on customer confirmations?
Amount of markdown or markup on a principal transaction. MSRB rules require that customer confirmations provide the name, address, and telephone number of the broker/dealer and the capacity of the firm in the trade (agent or principal). Amount of commission is required if the firm acted as agent, and the markup or markdown if the firm acted as principal.
An inherent risk associated with Auction Rate Securities is the potential to have:
An inherent risk associated with Auction Rate Securities (ARS) is the potential for a failed auction. These can occur due to a lack of demand, resulting in no bids being submitted when it is time to reset the rate. Auction Rate Securities use a Dutch auction method to reset the rate paid in the upcoming period known as the "clearing rate".
All of the following might lead to an industrial development bond being called EXCEPT:
An issuer of industrial development revenue bonds is likely to call bonds to reduce interest costs when interest rates are falling, discontinue interest payments if the facility is destroyed by a natural disaster, or reduce debt if funds are available in a surplus account. Industrial development revenue bonds are not affected by issuer's statutory debt limits as they affect the issuance of GO bonds only.
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
As an "except" question, we are looking for the false statement. The public service commission would have no approval power over revenue bond interest and principal payments. Because the bond is not backed by the taxing authority of the city it is a revenue bond, rather than a GO bond. The funds for payment of interest and repayment of principal are generated through the fees paid by those using the city's water and sewage facilities. Being a public, rather than private facility, these would not be AMT bonds.
A municipal bond is offered at a discount. It has a 30-year maturity and is callable in 20 years at par. It is callable in 5 years at a premium and is puttable in 10 years at par. Which of the following yields would be quoted on this basis?
Bonds that sell at a discount are always quoted as yield-to-maturity. This is the lowest possible net yield that the investor would make by holding the bonds until the issuer redeems them.
A newly-issued municipal bond pays interest on March 1 and September 1. If the bond has a dated date of August 1, 2019, the bondholder's first interest payment (payable on March 1, 2020) would include interest for a period of:
From the dated date of August 1, 2019, to the first payment date of March 1, 2020, is 7 months.
Which of the following would NOT be examples of overlapping debt? Debt to build a state office building within city limits. Debt to maintain a county park district serving a municipality. Debt backed by two states cooperating in the construction of a bridge. Debt for a high school district within city limits.
I and III State debt cannot overlap with any other municipal entity.
In what order, from first to last, would a syndicate member allocate orders for a new municipal bond issue? Presale orders. Designated orders. Member orders. Group net orders.
I, IV, II and III. The standard order priority for municipal bond issue allocation as stated within the syndicate letter is: presale, group, designated, and member. Orders that benefit all syndicate members have the highest priority.
A legal opinion evaluates which of the following features of a municipal issue? Marketability. Legality. Tax-exempt status. Economic feasibility.
II and III A legal opinion rendered by bond counsel deals with the tax-exempt status of the proposed issue and its legality. The marketability of the new issue of bonds is dealt with by the syndicate. Economic feasibility relates to revenue bond issues and is performed by independent consultants.
A project that was funded with a revenue issue has been condemned by the state under an eminent domain proceeding. The outstanding bonds would be subject to which of the following call provisions?
If a revenue project was condemned under eminent domain, the bonds would be subject to a catastrophe call.
An investor in the 28% income tax bracket is considering purchasing either a 4% municipal bond or a 5% corporate bond. Which of the following statements regarding the two bonds' after-tax yields is TRUE?
Investors should invest in municipal bonds if the return after taxes is higher than comparable taxable bonds. To compare the two bonds, use the tax-free equivalent yield formula: (taxable yield) x (100% - tax bracket) = (tax-free equivalent yield). In this case, 5% x (100% - 28%) = 5% x .72 = 3.6%. Because the municipal bond yields 4% tax free, the investor should buy it; after taxes have been paid, the corporate bond yields only 3.6%.
All of the following are allowable municipal dealer quotes EXCEPT
MSRB Rule G-13 requires municipal brokers and dealers to give bona fide bids and offers for municipal securities (bona fide quotes are those good for trading). It also allows for requests for bids (BW = bids wanted) and requests for offers (OW = offers wanted). A nominal quote (those for informational purposes only) is permissible, but only if it is identified as such.
A confirmation to a customer purchasing a new issue of municipal securities must disclose all of the following EXCEPT:
MSRB confirmations must include the customer's name, trade and settlement dates, coupon rate and maturity, and the yield to maturity or yield to call (whichever is lower). The current yield (annual interest/current market price) is not included on confirmations.
A registered representative is attempting to close a large municipal bond sale, but the customer voices concern about a potential increase in interest rates. Which of the following actions are permitted by MSRB rules?
MSRB rules prohibit a municipal securities dealer from guaranteeing a customer against loss, or promising to repurchase securities at a set price for their own account. MSRB rules permit the sale of bona fide put options or repurchase agreements to customers by municipal securities dealers. Sharing in any profits or losses is prohibited.
All of the following items of information must be included in a municipal securities confirmation EXCEPT:
MSRB rules require that certain information be included on all municipal confirmations, including the capacity in which the firm acted in filling the order, whether the bonds are in registered or book entry form, and any relevant call provisions. Information on catastrophe or extraordinary call provisions is not included on a confirmation because catastrophes have no planned dates of occurrence.
Which of the following is federally tax exempt for a corporation?
Municipal bonds are tax exempt for corporations as well as for individuals. Preferred stock dividends are taxable but at a reduced rate for corporations due to the 50% dividend exclusion. That break does not apply to the dividends on foreign securities. Regardless of the security, capital gains are taxable.
Which of the following is the computation for the coverage ratio for a municipal revenue bond issue?
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.
Your firm is interested in submitting a bid on a forthcoming general obligation municipal bond issue. Your firm could obtain the appropriate bid worksheets through a service provided by:
Official notices of sale announcing the offering of municipal issues to competitive bidders are published in the Bond Buyer, which offers a service to subscribers-called the New Issue Worksheet and Record Service-that summarizes each notice. It provides information about new issues put up for bid and worksheets for underwriters to determine yields and prices when bidding.
Which of the following would be most likely to require a mandatory sinking or surplus fund?
Sinking or surplus funds force revenue bond issuers to set aside a portion of their revenue for debt retirement.
The 30-day visible supply published in the Bond Buyer contains:
The 30-day visible supply consists of new issue GO and revenue municipal bonds expected to be offered in the next 30 days. It does not include short-term anticipation notes.
All of the following MSRB Rules of Uniform Practice requirements may be altered by mutual agreement between dealers EXCEPT the:
The MSRB regulates the contents of confirmations to standardize information. There must be an original record of the agreement even though dealers may mutually agree to change the terms.
All of the following are required by the MSRB on customer confirmations EXCEPT:
The price the dealer originally paid for the bond.
A municipal bond, issued with a covenant that states, "If revenue collections are not sufficient to meet debt service requirements, the issue will be backed by the full faith and credit of the municipality," is known as a:
When a municipal bond is backed by both a source of revenue and the taxing ability of the issuer, this is referred to as a double-barreled bond. So source of revenue AND taxation equals a double barreled bond
A customer buys a municipal bond in the secondary market at 96 that has 4 years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are:
When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is 1 point per year (4 points divided by 4 years to maturity). Therefore, when the bond is sold 2 years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of 1 point per bond. Also, there is ordinary income taxation on the accretion of 2 points.
All of the following statements regarding a negotiated underwriting are true EXCEPT that:
When a municipality appoints an underwriter, the bond issue is a negotiated underwriting. The price must be satisfactory to the issuer and still allow the underwriters to sell the bonds at a profit. There is no requirement that either municipal GO or revenue issues be underwritten as either negotiated or competitive bid. Each may be underwritten using either underwriting process.
If a municipal bond rated BBB is pre-refunded, all of the following statements are true EXCEPT
When funds are escrowed to call in a bond at a predetermined call date, the bond is said to be pre-refunded. The money set aside is invested in government securities, which makes the issue very safe and highly marketable. The rating of pre-refunded bonds is AAA, as they are now backed by U.S. government securities.
The placement ratio, as shown in the "Bond Buyer", represents the dollar value of:
bonds placed divided by bonds offered The placement ratio is a measure of investor demand for new issue municipal bonds. It is computed by dividing the dollar amount of bonds placed (sold) each week by the dollar amount offered that week. A high ratio indicates a strong demand while a low ratio reveals the opposite. Although not tested, historically, there have been weeks (rare) where the placement ratio has been 0%. Fortunately for the underwriters, it is not unusual to see a ratio of 100%.
The spread in a municipal competitive bid is the:
difference between the bid and production (the price at which the bonds are reoffered to the public). Bid refers to the winning bid and is the price the syndicate pays to buy the bonds from the issuer. The term "production" is a sales term and refers to the price at which the bonds are reoffered to the public. The difference between the two is the spread.
A syndicate member in a municipal underwriting wishes to place an order with the manager for its own portfolio. Under MSRB rules, an order for a related portfolio must be:
disclosed to the manager.
Alternative minimum tax (AMT):
is assessed against high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income.
All of the following statements about municipal brokers' brokers are true EXCEPT that they:
perform trades on a principal basis only. A broker's broker does not maintain an inventory of bonds. Therefore, they do not act as principals; they act as agents only in trades between dealers or between institutions. They do no retail business.
The doctrine of reciprocal immunity most accurately describes:
the view that neither the states nor the federal government may tax income received from securities issued by the other. The principle that neither the states nor the federal government may tax income received from securities issued by the other is known as the doctrine of reciprocal immunity. States may, however, tax the interest on debt securities of other states. This doctrine provides the original basis for the federal income tax exemption on interest paid on municipal debt securities.
