STC Series 7 Chapter 6, 7, and 8: Corporate & Municipal Debt, and U.S. Treasury and Government Agency Debt

Name & describe a few types of Municipal Notes?

- Tax Anticipation Notes (TANs): These are issued to finance current municipal operations in anticipation of future tax receipts from property taxes. They're usually general obligation securities. - Revenue Anticipation Notes (RANs): These are issued for the same purpose as TANs except that the anticipated revenues are typically federal or state subsidies. Like TANs, they're usually general obligation securities. - Tax and Revenue Anticipation Notes (TRANs): These are created when TANs and RANs are issued together. - Bond Anticipation Notes (BANs): These are issued to obtain financing for projects that will eventually be financed through the sale of long-term bonds. - Grant Anticipation Notes (GANs): These are issued in expectation of receiving funds (grants) from the federal government. - Construction Loan Notes (CLNs): These are issued by municipalities to provide funds for construction of a project that will eventually be funded by a bond issue.

Name the types of types of Money-Market Securities?

1) Commercial paper 2) Bankers' acceptances 3) Negotiable certificates of deposit 4) Federal funds 5) Money-market funds 6) Repurchase agreements (Repos)

Name the types of Non-U.S. Market Debt?

1) Eurodollar Bonds 2) Yankee Bond 3) Eurobond 4) Sovereign Bond

Name the major categories of Municipal Bonds?

1) General Obligation (GO) Bonds 2) Revenue Bonds

Describe the following type of Secure Bond: Mortgage Bonds? What's the collateral for this type of bond?

1) Mortgage Bonds - Collateral = Real Estate Mortgage bonds are secured by a first or second mortgage on real property; therefore, bondholders are given a lien on the property. Normally, mortgage bonds are issued serially over a number of years. In other words, as one group of bonds are paid off, the company will issue a new group to be secured by a mortgage on the same piece of property.

What's the order of liquidation for a Chapter 7 Bankruptcy?

1. Secured creditors, including secured bonds 2. Wages (payroll) 3. Taxes 4. General creditors, including debentures 5. Subordinated creditors, including subordinated debentures 6. Preferred stockholders 7. Common stockholders

Describe the following type of Non-U.S. Market Debt: Eurodollar Bonds?

A Eurodollar is a dollar-denominated deposit that's made outside of the United States. Eurodollar bonds pay their principal and interest in U.S. dollars, but are issued outside of the U.S. (primarily in Europe). The issuers of Eurodollar bonds include U.S. and foreign corporations, foreign governments, and international agencies, such as the World Bank. These bonds are not registered with the SEC and, consequently, may not be sold in the U.S. until 40 days have elapsed from the date of issuance. For this reason, they're bought primarily by foreign investors. As with domestic U.S. bonds, movements in U.S. interest rates can greatly affect the prices of Eurodollar bonds.

What effect does a municipality's Ability to Collect Taxes have on the issuance of a General Obligation (GO) Bond?

A community's tax limitations and budgetary considerations must also be reviewed. Attempts to limit the maximum amount of debt that a municipality may carry will positively influence general obligation bonds since the projected revenues will be directed to service the alreadyissued debt. In this way, fiscal responsibility is imposed and the creditworthiness of the issuer is enhanced. Since most general obligation issues are secured by property taxes, the tax collection record of the community is an essential component of quality analysis. A poor collection record may be a red flag that's indicative of an inefficient local government which may result in bonds with low credit ratings. Other red flags or negative trends that may affect an issuer's credit are property taxes that are increasing in the face of a declining population, an increasing tax burden on the community in comparison to other regions, or general obligation debt that's increasing while property values remain stagnant.

Define & Describe all components of a Municipality's Debt Statement?

A critical tool available to those analyzing the debt of a municipality is the debt statement. The various components of the debt statement are: * Direct Debt: All the debt (bonds and notes) that's been issued by the municipality * Net Direct Debt: The direct debt (all issues) minus any self-supporting debt, such as revenue and note issues. In general, the net direct debt is only the general obligation debt (bonds supported by taxes). * Overlapping Debt: This is the result of multiple authorities in a given geographic area having the ability to tax the same residents (examples below). * Total Bonded Debt: The sum of both the long- and short-term debt of a municipality, plus its applicable share of overlapping debt. The following examples illustrate the concept of overlapping debt: Example 1) Broward County, Florida issues a general obligation bond that's secured by the assessed value (property tax) within Broward County. Since the city of Fort Lauderdale lies within Broward County, part of the assessed value that secures the county debt lies in Fort Lauderdale. Due to the fact that the county's debt overlaps Fort Lauderdale, Fort Lauderdale is ultimately responsible for a portion of the county's debt. Example 2) The debt of a school district is comprised of one or more cities or towns. If a city and school district lie within the same boundaries, they're said to be coterminous and, when examining the debt of the city, the school district's debt must be shown as overlapping debt. To assist analysts in comparing the debt of different communities, the ratio of debt to a number of different factors may be used. Typically, the analyst will use the ratio of net direct debt plus overlapping debt (net overall debt) to assessed value or to population (debt per capita). An analyst might also use the ratio of annual debt service to tax and other income to assess the quality of a GO issue. In this case, a high ratio is indicative of a decreasing margin of safety in the issuer's ability to repay principal and interest. If the debt service increases and tax and other income remains stagnant or decreases, there are less funds available to pay the debt service.

Describe: General Obligation (GO) Bonds?

A general obligation bond is secured by the full faith, credit, and taxing power of the issuer. Therefore, only issuers that have the ability to levy and collect taxes may issue general obligation bonds. State or local governments are able to issue general obligation bonds based on their statutory or constitutional powers. However, prior to issuing general obligation bonds, issuers must obtain voter approval. Essentially, this requirement is due to the fact that taxpayer money is being used to pay debt service.

Describe the following type of Unsecure Bond: Guaranteed Bonds?

A guaranteed bond is one that, along with its primary form of collateral, is secured by a guarantee of another corporation. The other corporation promises that it will pay interest and principal if necessary. A typical example is a parent company guaranteeing a bond that's issued by a subsidiary company.

Describe the following type of Revenue Bond: Parity Bonds?

A parity bond exists when two or more issues of revenue bonds are backed by the same pledged revenues.

Describe the following type of Unsecure Bond: Stepped Coupon Bonds?

A stepped coupon bond is issued with a low coupon that increases at regular intervals. The issuer generally reserves the right to call the bond on the dates that the coupon is reset. These are also referred to as dual coupon or step-up coupons.

Describe the following concepts: - Accretion - Capital Appreciation Bond (CAB) - Compound Accreted Value (CAV)

Accretion: Although a zero-coupon bond doesn't provide the purchaser with semiannual interest payments, the basis (value) of the bond must be upwardly adjusted each year over its life. The adjusted dollar value of the bond is referred to as its accreted value (or accumulated value to date). The increase in the bond's value is considered phantom income and, for tax purposes, considered taxable interest income. A bond's accreted value may be higher or lower than the market value of the bond. For exam purposes, if any reference is made to a capital appreciation bond (CAB), it's a bond that's similar to a zero-coupon bond. CABs don't pay periodic interest and are unsuitable for investors who are seeking income. Their cost basis equates to the compound accreted value (CAV), which is calculated by adding the initial principal amount to the accreted value to date.

Define & Describe: 529 ABLE Plans?

Achieving a Better Life Experience (ABLE) plans (also referred to as 529A ABLE plans) are municipal fund securities that can be purchased to help support individuals with disabilities without jeopardizing their disability payments received from Social Security, Medicaid, or private insurance. The maximum contribution is $16,000 per year and front-loading is not permitted. The individual's other disability payments will continue if the account's value doesn't exceed $100,000. Distributions from the plans are tax-free if they're used to pay qualified expenses.

Define & Describe: Ad Valorem Tax? What is Ad Valorem Tax associated with?

Ad valorem tax (property tax) is determined based on the assessed value of property multiplied by the tax rate levied (expressed in terms of mills). One mill expressed as a percentage is 0.1% or, if expressed as a decimal, it's 0.001. Ultimately, if a rate of one mill is used for tax purposes, it equates to a tax of $1 per $1,000 of assessed value. - For example, a taxpayer owns property that's assessed at a value of $300,000 and is subject to a tax of 7 mills. This means that property tax of $2,100 is owed ($300,000 x .7% or $300,000 x .007). In addition to property taxes, sales taxes, and income taxes, other non-tax revenue, such as parking fees, park and recreational expenses, and licensing fees, may be used to pay the debt service on GO bonds. Certain governmental entities, such as school districts, may have an imposed legal limit on the tax rate at which they may assess. Bonds issued by these entities are called limited tax general obligation bonds since the taxing power of the issuer is limited to a specified maximum rate. Unlimited tax general obligation bonds are issued by government units that have no legal limitation on their taxing power. Most local general obligation bonds are unlimited tax bonds; therefore, the issuers have the ability to levy ad valorem taxes without limitation as to the rate or the amount.

What are the basic pros & cons for a company to issue debt?

Advantage: issuing bonds over stock is that the corporation doesn't give up partial control of the company or give up a portion of its profits. Downside: company required to repay the money borrowed with interest. The requirement to make semiannual interest payments will lower the corporation's profits for as long as it has debt outstanding.

What type of orders can an existing holder of ARSs choose to place?

An existing holder of ARSs may choose to place the following orders: - Hold at Market: this order indicates the amount of the security he wishes to continue to hold regardless of the clearing rate that's set by the auction. Additionally, if an owner doesn't place an order, the assumption is that he has elected to continue to hold the securities regardless of the clearing rate. - Hold at Rate or Bid: this order indicates the holder's bid to continue to hold an existing position at a specified minimum rate. - Sell: this order indicates the holder's desire to sell an existing position regardless of the rate that's set by the auction. A potential buyer has the option to place a: - Buy order: this indicates a new investor's desire to buy a new position at a specified minimum rate (this order may be entered by new buyers or existing holders who are interested in adding to their position at a specified rate).

Describe the following type of Non-U.S. Market Debt: Yankee Bond?

Another common type of bond that's denominated in U.S. dollars is a Yankee bond. Yankee bonds allow foreign entities to borrow money in the U.S. marketplace. These bonds are registered with the SEC and sold primarily in the United States.

Define & Describe: Variable Rate Demand Obligations (VRDOs)?

Another long-term security that's marketed as a short-term investment is a variable rate demand obligation (VRDO). A VRDO's interest rate is adjusted at specified intervals (daily, weekly, monthly) and, in many cases, this adjustment allows the owner to sell or put the security back to the issuer or a third party on the date that a new rate is established. If this is done, the investor will receive the par value plus accrued interest. It's important to understand the difference between a VRDO and a municipal ARS. Although they're 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. If an ARS auction fails, the investor may not have immediate access to his funds. ARSs use an auction process to reset the interest rate on the securities; however, VRDOs have an interest rate that's reset by the dealer at a rate that allows the security to be sold at par value. Investors who are interested in short-term investments may also purchase other tax-free money-market instruments such as tax-exempt commercial paper and tax-free money-market funds. Tax-exempt commercial paper has a maximum maturity of 270 days and is normally backed by a bank line of credit.

Describe the concept of Arbitrage?

Arbitrage is a technique that involves profiting from price differentials in the same or similar security. There are times when the market price of a convertible bond doesn't reflect the value of the common stock that will be received if the bond was converted into stock. If this situation occurs, the convertible bond will be selling at a discount to parity and arbitrageurs could profit from this differential. - For example, a convertible bond has a conversion ratio of 40 shares and is selling at $1,350 while the stock is priced at $35. Although conversion parity is $1,400 ($35 x 40 shares per bond), an arbitrageur could buy the bond at $1,350 and convert it into stock worth $1,400, yielding a profit of $50 per bond. This profit potential will exist until the bond's price increases to at least $1,400.

Describe the Ratings for Municipal Notes?

As explained in the Bond Fundamentals Chapter, Moody's and Standard and Poor's issue ratings for fixed-income securities. Both organizations also have a rating system for municipal notes. Moody's has four rating categories for municipal notes and variable rate demand obligations (VRDOs). The first three ratings are considered Moody's Investment Grade (MIG) ratings, with the fourth considered a speculative grade. VRDOs, which will be described below, receive ratings based on a variation of the MIG scale—the Variable Municipal Investment Grade (VMIG) system. MIG 1 (VMIG 1): Superior credit quality MIG 2 (VMIG 2): Strong credit quality MIG 3 (VMIG 3): Acceptable credit quality SG: Speculative grade credit quality Standard and Poor's has the following four rating categories for municipal notes: SP-1+: Very strong capacity to pay principal and interest SP-1: Strong capacity to pay principal and interest SP-2: Satisfactory capacity to pay principal and interest SP-3: Speculative capacity to pay principal and interest

Describe the following type of Unsecure Bond: Zero-Coupon Bonds? In what type of account are Zero-Coupon Bonds normally placed?

As the name suggests, zero-coupon bonds don't pay periodic interest. Instead, an investor purchases a zero-coupon at a deep discount from its par value, but is able to redeem the bond for its full face value at maturity. The difference between the purchase price and the amount that the investor receives at maturity is considered the bond's interest. Typically, the longer the zero coupon bond's maturity, the deeper its discount from par value. Investors who purchase zero-coupon bonds often do so knowing that they're going to need a lump sum of money at some future date. - For example, an investor knows that she will need $20,000 in 20 years to pay for her daughter's first year of college; therefore, she buys a zero-coupon bond with a par value of $20,000. The investor pays $5,000 for the bond and, although she will not receive periodic interest payments, she will receive $20,000 when the bond matures in 20 years. Zero-coupon investments are often placed into tax-protected accounts, such as IRAs or other retirement accounts to avoid the taxation of the phantom interest. However, if the bond is placed in a taxable account, the increase in value (accretion) would become taxable income each year even though the customer has not received any actual interest. This tax implication should be discussed with a client prior to the purchase of any specific zero-coupon bond. Please note that not all zero-coupon instruments are subject to this taxation. For example, a zero-coupon municipal bond is not subject to this liability due to the tax exemption afforded to municipal bond interest.

Describe the following type of Money-Market Security: Bankers' Acceptances (BAs)?

Bankers' acceptances are instruments that are used to facilitate foreign trade. For example, an American food company is importing French snails. The American company may wish to pay for the snails after delivery and, therefore, it issues a time draft (i.e., a check that's good at a future date) which is secured by a letter of credit from a U.S. bank as payment. The French snail manufacturer is able to hold the draft until its due date and receive the full amount or may cash it immediately at a bank for a discounted amount. At that point, the bank has the draft guaranteed by the issuing bank and it becomes a banker's acceptance. Now, the bank may choose to hold it until its due date or sell it in the market. BAs are actively traded and are considered quite safe since they're secured both by the issuing bank and by the goods that were originally purchased by the importer.

Define: Bankruptcy? What are 2 types of bankruptcy that corporations can file?

Bankruptcy= when a corporation cannot pay its creditors, it may be required to file for bankruptcy. 1. Chapter 7 - Liquidation - A corporation that's going out of business will need to file under Chapter 7. In this case, a court will appoint a trustee to liquidate (i.e., sell) all of the company's assets to pay creditors and then pay shareholders. 2. Chapter 11 - Reorganization - If a company wants to reorganize its debts, it will file for bankruptcy under Chapter 11. In such a case, the corporation will negotiate new terms with its existing bondholders to avoid going out of business entirely.

Describe the following type of Money-Market Security: Negotiable Certificates of Deposit (CDs)?

Banks and savings and loans issue the original certificates of deposit which are time deposits that carry fixed rates of interest and mature after a specified period. Negotiable CDs have the following characteristics: - They're short-term instruments that have maturities that range from two weeks to one year. - They have a minimum denomination of $100,000, but often trade in denominations of $1,000,000 or more (also referred to as jumbo CDs). - The Federal Deposit Insurance Corporation (FDIC) provides insurance of up to $250,000 per depositor. - FDIC will cover joint accounts up to $500,000, with $250,000 allocated to each person. The typical purchasers of negotiable CDs are wealthy individuals and institutions, such as corporations, insurance companies, pension funds and mutual funds. These instruments attract investors who are seeking a return on their cash in a low-risk and liquid investment. If investors hold negotiable CDs to maturity, they receive the face amount from the issuer and the CDs expire. However, if the investors choose not to hold them to maturity, they can sell them in the secondary market without penalty

Describe the Effect of Stock Splits and Stock Dividends on Conversion Price and Conversion Ratio?

Both the conversion price and conversion ratio are established at the time the bonds are issued and will not change unless there's a change in the underlying stock. Two types of corporate actions that create the need to adjust the conversion price and conversion ratio include are stock splits and the declaration of a stock dividend. The adjustment may be required due to an existing non-dilutive feature or covenant in the bond's indenture. Remember, forward stock splits don't change a stock's absolute value; instead, they create more shares that are worth proportionately less. Let's use an example of a bond that's originally convertible at $40, resulting in a conversion ratio of 25 shares. If the stock is split 2-for-1, then: - The conversion ratio will increase to 50 shares (25 x 2 /1) and - The conversion price will decrease to $20 ($40 x 1 /2) Again, using a bond that's convertible at $40, if the company declares a 20% stock dividend, then: - The conversion ratio will increase by 20% to 30 shares (25 x 20% = an extra 5 shares) and - The conversion price will decrease to $33.33 ($1,000 ÷ 30 shares)

Describe the following type of Revenue Bond: Build America Bonds (BABs)?

Build America Bonds are taxable municipal bonds that were issued under the American Recovery and Reinvestment Act of 2009 (ARRA). Although the program officially ended in 2010, a student should still be aware of their fundamental characteristics. BABs were intended to help state and local governments finance capital projects at a substantially lower cost. Examples of capital projects include creating public infrastructure (e.g., public schools and roads) and transportation infrastructure (e.g., rail, bridges and ports, and public buildings). The objective was to broaden the appeal of municipal securities to taxable, fixed-income investors. One form of BAB is a Direct Payment bond which was issued by municipalities to raise capital for all the traditional purposes except for refundings, private activities, and 501(c)(3) borrowers. To help defray the cost of borrowing, the Direct Payment BABs provided issuers with a reimbursement (subsidy) from the U.S. Treasury for 35% of the interest paid on the bonds. - For example, if a municipality issues a BAB at a taxable rate of 6.25%, the issuer will receive 2.19% (6.25% x 35%) annually from the U.S. Treasury. Therefore, the net amount of interest being paid by the issuer is 4.06% (6.25% - 2.19%). Although taxable, BABs were issued by municipal governments and subject to MSRB rules. Brokerdealers involved in the underwriting of these bonds were required to provide official statements to purchasers and all sales activities were supervised by Municipal Securities Principals.

Describe the following concepts of a 529 College Savings Plans: - Contribution Limits

Contribution Limits - Although current tax law allows a tax-free gift of up to $16,000 to any one person in any given tax year, a 529 plan may be front-loaded with an initial gift of $80,000 which is treated as if it's being made over a five-year period (five contributions of $16,000 each). Individuals may contribute these same amounts to 529 plans that are maintained for more than one beneficiary. In other words, if an individual has five grandchildren, she's able to contribute $80,000 to each grandchild's 529 plan without incurring federal gift taxes. This amount is doubled for a married couple funding multiple 529 plans. The aggregate amount able to be contributed to a 529 plan is determined by the state. Most states use a total that's sufficient to pay for an undergraduate degree.

How is conversion in either Convertible Bonds or Convertible Preferred Stock taxed?

Conversion is NOT Taxable! If the owners of convertible bonds or convertible preferred stock convert those securities into the common stock of the corporation, the conversion is NOT a taxable event. When these securities are converted, the cost basis for the common stock that's received will be based on the cost basis of the original security. - For example, an investor purchased a convertible RFQ corporate bond for $1,200 and converted the bond into 40 shares of common stock. The investor's overall cost basis will be $1,200, while her cost basis per share will be $30 ($1,200 divided by 40 shares). If the stock was later sold for $32 per share, she would report a capital gain of $2 per share, or $80.

Define: Convertible Bonds?

Convertible Bond: allows an investor to convert the par value of the bond into predetermined number of shares of the company's common stock. In order to offer investors more of an incentive to buy its bonds, a corporation with a weak credit rating may issue convertible bonds. For the purchaser, the tradeoff for this opportunity is that convertible issues traditionally offer lower coupons than similar non-convertible issues. If the bonds are converted, the debt becomes equity and the issuers' capital structure will be significantly altered.

What are Advantages and Disadvantages of Convertible Bonds?

Convertible bonds allow corporations to borrow money at a lower rate (lower coupon) since the convertible feature is attractive to investors. Investors are willing to accept the lower interest rate in exchange for the opportunity to convert the bonds into common stock. Convertible bonds provide investors with a greater degree of safety than preferred or common stock, but also offer them the potential for capital appreciation if the underlying stock rises in value. In addition, the investor has some downside protection because, even if the price of the stock falls, the convertible bond still has inherent value as a bond. A disadvantage to convertible bonds is that if all of the bonds are converted into stock, then the number of outstanding shares may increase dramatically. This will cause the stockholders' equity to be diluted and the earnings per share (EPS) to decrease. At this point, the company will need to divide the earnings over a larger group of shareholders, thereby giving each of them a smaller percentage. In order to reflect this possibility, a company's EPS may need to be restated as fully diluted EPS—a figure that assumes all conversions have been made. From the issuer's point of view, conversion adjusts the mandatory debt obligation into equity and deleverages the corporation's balance sheet. This deleveraging is useful because it removes both the near-term and long-term debt service obligations. Remember, dividend payments to common shareholders are voluntary, while interest payments to bondholders are mandatory. Therefore, after conversion, the former bondholders are no longer owed money at maturity. The bonds are eliminated and will be replaced with an ownership interest.

Describe the following type of Unsecure Bond: High-Yield (Junk) Bonds?

Corporate bonds that are rated below investment grade (below BBB by S&P or below Baa by Moody's) are referred to as high-yield or junk bonds. The lower rating indicates that bond analysts are uncertain about the issuer's ability to make timely interest payments and to repay the principal. In other words, these bonds carry a higher-than-normal credit risk. High-yield bonds must pay higher coupons in order to compensate investors for the added degree of risk that's associated with these investments. Essentially, these bonds are suitable only for speculative investors. If bonds start out with an investment-grade rating, but are later lowered to below investment grade, they're referred to as fallen angels.

What investor profile should Money-Market Securities be offered for?

Essentially, money-market instruments may be viewed as a safe haven for investors. For example, if a customer has liquidated a long-term investment position and is evaluating different investment options, investing in a money-market instrument may be a good idea. Alternatively, if an investor intends to make a large purchase in the near future (e.g., a home or a business), the funds may be invested in money-market instruments since they normally have very stable prices. Remember, the sooner an investor needs access to funds, the less risk she can take with her principal. With exam questions, an important point to consider is the objectives of the investor. An investor who is interested in capital preservation may seek a money-market equivalent that's backed by the U.S. government, such as a T-bill. A high income investor may seek a money-market equivalent that's tax-free. Investors may also obtain access to these types of securities by making an investment in a money-market mutual fund.

Does every municipal issue need to include a legal opinion? Define: Unqualified Legal Opinion & Ex-Legal?

Every municipal issue MUST be issued with a legal opinion. The legal opinion is written by a recognized bond counsel that's hired by the issuer to attest to the validity and tax-exempt status of the bond issue. Essentially, the legal opinion assures investors that the issuer has the legal right to issue the bonds. - Unqualified Legal Opinion= if there are no existing situations that could adversely affect the legality of an issue, the bond counsel renders an unqualified legal opinion. Potential adverse situations include an issuer of a revenue bond not having a clear title to a property or an issuer that's violating local, state, or federal statutes when developing a project. - Ex-Legal= Delivery of certificates without legal opinions or other documents that are legally required to accompany the certificates will not constitute good delivery unless they're identified as ex-legal at the time of the trade.

How does the fiscal responsibility & nature of the municipality's debt trend have an effect on the issuance of a General Obligation (GO) Bond?

Examining the fiscal responsibility of the issuer's past attitudes toward debt is often an indicator of the issuer's present, and possibly future, ability to engage in fiscally sound behavior. Some important considerations include whether the issuer has maintained a balanced budget over the last five years and how well the issuer has maintained fund reserves. Any analysis must also review a municipality's debt trend. If a community has used debt to support the growth of its suburbs (such as building roads and schools that are needed to support that growth), the debt is not necessarily bad. Conversely, if debt has been issued to finance budget deficits or to increase spending in a weak local economy, this may be an indication of an unwise fiscal policy.

Define & Describe: Exchange-Traded Notes (ETNs)? What type of product is this?

Exchange-Traded Notes (ETNs)= type of unsecured debt security, but differs from other types of fixed-income securities since ETN returns are often linked to the performance of an index (some ETN returns may be linked to a commodity or currency). ETNs don't usually pay an annual coupon (they're zero-coupon-like) or specified dividend; instead, all gains are paid at maturity. These securities are traded on an exchange, such as the NYSE, and may be purchased on margin and sold short. Investors may also choose to hold the debt security until maturity. A significant characteristic of ETNs is that they carry issuer risk which is tied to the creditworthiness of the financial institution backing the note. With an ETN, an investor is merely buying a promise from the issuing institution that it will pay the index's return, minus any fees. Therefore, the investor is not only taking a chance on the performance of the benchmark index, she's also assuming the risk that the issuer may fail to make good on its promise. If the issuer's financial condition deteriorates, it could negatively impact the value of the ETN, regardless of how its underlying index performs.

What are the risk factors & suitability issues associated with Reverse Convertible Securities?

Higher Coupon, Higher Risk - From an investor's perspective, he's betting that the value of the underlying asset will remain stable or rise, while the issuer is betting that the value will fall. In the typical best case scenario, if the value of the underlying asset stays at or slightly above the knock-in level, he will receive a high coupon for the life of the investment as well as the return of the full principal in cash. However, in the worst case, if the value of the underlying asset drops below the knock-in level (which may be 70 to 80% of the original value), the issuer is able to pay back the principal in the form of the depreciated asset. The result is a potential loss of some, or all, of the original principal. Suitability Issues - Obviously, these derivative securities are only suitable for investors who understand the inherent risks of the products. While the higher-than-average coupon may be appealing, reverse convertible investors must understand the potential loss of principal on their investment. Remember, if the underlying asset falls in value, the investor may be forced to take the underlying asset in exchange for the par value at maturity. Also, for the higher coupon, investors sacrifice any upside appreciation in the value of the underlying asset.

Describe the following type of Revenue Bond: Housing Revenue Bonds & Dormitory Bonds?

Housing Revenue Bonds - These are issued by state or local housing finance agencies in an effort to help fund single family or multifamily housing and are normally for low or moderate income families. In some cases, the proceeds of the bond offering are lent to the real estate developers that are constructing the property. In other situations, the money being raised through the offering is used to support the mortgage markets. Dormitory Bonds - These are issued to build housing for students at public universities and are repaid from a portion of student tuition payments.

Describe the following type of Revenue Bond: Private Activity or Alternative Minimum Tax (AMT) Bonds

If 10% or more of the bond proceeds will be used to finance a project for a private entity (e.g., a corporation or professional sports team) and if 10% or more of the bond proceeds will be secured by property used in the private entity's business, the bonds are referred to as private activity bonds. The interest earned on a private activity bond may be subject to the AMT and the bond's interest may be taxed at the federal level. Due to the potential tax implication, these bonds may trade with a higher yield than issues that are not subject to this rule.

Which disclosures must be made if a brokered CD is callable?

If a brokered CD is callable, the following disclosures should be made: - At its sole discretion, the issuer may decide to call in the CD prior to maturity. - If a CD is called prior to maturity, the client may be unable to reinvest the funds at a comparable rate of interest (if rates have declined). - A CD that's called prior to maturity may offer a client a return that's less than its yield-to-maturity. - If the CD is not called by the issuer, the client may be required to hold the security until maturity.

What effect does Litigation have on a municipality's issuance of a General Obligation (GO) Bond?

If a community is involved in a lawsuit, any liability that a municipality is obligated to pay will place a financial burden on the community. Such litigation will generally have a negative effect on the community's ability to pay the debt service on outstanding bonds. Conversely, the receipt of non-tax revenues, such as federal payments for education, may serve to enhance the community's ability to pay the required debt service.

Define & Describe: Parity?

If a convertible bond's conversion value (the market value of the stock received at conversion) is equal to its market price, then the bond is considered to be trading at parity. Most bonds trade at a premium to parity, which means that the market price of the bond is higher than the aggregate market value of the stock the investor will receive if he converted. - For example, if the conversion value of Widget's 10% subordinated debentures is $750 ($30 x 25 shares) and its market price is $900, then the bond is selling at a 20% premium to parity (20% of $750 is $150).

Describe the effect of market action on Convertible Bonds?

If interest rates are stable, most bond prices will have little movement. However, a convertible debenture could show significant price appreciation or depreciation if the underlying common stock changes in value. The conversion feature essentially links the bond's value to the underlying stock's value. If the underlying stock appreciates, the bond will trade at a price based on its potential conversion value. However, if the price of the underlying stock declines to the point where the conversion feature offers no advantage, the bond will simply trade at a price that's based on its inherent value as a bond.

Describe the following type of Money-Market Security: Repurchase Agreements (Repos)?

In a repurchase agreement (repo), a dealer sells securities (usually T-bills) to another dealer and agrees to repurchase them at both a specific time and price. In effect, the first dealer is borrowing money from the second dealer and securing the loan with securities (a collateralized loan). In return for making the loan, the second dealer (the lender) receives the difference between the purchase price and the resale price of the securities. If a dealer purchases securities and agrees to sell them back to the other dealer at a specific date and price, this is referred to as a reverse repo or matched sale. In this situation, the first dealer loans money (with securities as collateral) to the second dealer and earn the difference in sales prices. Many corporations, financial institutions, and dealers engage in repos and reverse repos. These types of transactions are typically short-term, with most being overnight transactions.

In terms of Analyzing Revenue Bonds, describe the Trust Indenture Covenants

In addition to the debt service coverage ratio, there are various provisions that are found in the bond's indenture that should be examined when analyzing revenue bonds. The indenture is also referred to as the bond resolution or trust agreement. The indenture is a contract between the issuer and the trustee that has been appointed to represent the bondholders' interests. The indenture includes a variety of provisions that establish the issuer's responsibilities and the bondholders' rights. Since the indenture describes the legal protections that are afforded to bondholders, it's essential to analyze some of the various covenants (promises). The typical covenants include: * Rate Covenant: The issuer's pledge to maintain rates at a level that's sufficient to meet operation and maintenance costs, debt service, and certain reserve funds. * Maintenance Covenant: The issuer's pledge to maintain the project in good working order. * Insurance Covenant: The issuer's pledge to carry insurance on the property. * Financial Reports and Audits: The issuer's pledge that it will maintain proper records and that an accounting firm will be retained to do an outside audit. This pledge is designed to avoid the possibility of funds being misused. * Issuance of Additional Bonds: If there's a closed-end indenture, no additional bonds that have an equal claim on the pledged revenues may be issued against the same security. However, if there's an open-end indenture, additional bonds may be issued in the future for expansion of the project. Revenue bonds with an additional bonds covenant must meet a certain earnings test before news bonds can be issued. This ensures that the issuer will be able to pay its obligations to both new and existing bondholders. * Non-Discrimination Covenant: This represents the issuer's pledge that no special rates will be granted to any person or group. * Catastrophe Call This provision provides municipalities with insurance against natural disasters. It allows for the early redemption of the bond if a catastrophic event occurs that severely damages the project which is financed by the bond offering. * Credit Enhancements: Credit from entities other than the issuer may be obtained to provide security for the debt financing. This may come in the form of bond insurance, letter of credit, or state (or other) government guarantees.

Describe the following type of Revenue Bond: Taxable Municipal Bonds?

In certain cases, a municipality may not be able to issue bonds that are exempt from federal income tax. This may occur when the bonds are issued to finance projects that don't provide a significant benefit to the general public. Some examples of situations in which a bond may lose its tax exemption include: 1) an offering where the proceeds are being used to build a sports facility or certain types of housing, or 2) an offering designed to allow an issuer to borrow funds in order to replenish its unfunded pension liabilities. Since these bonds will have higher yields, they may be suitable for investors who are unconcerned about the tax status of the investment (e.g., pension funds and retirement accounts).

Describe the following type of Unsecure Bond: Income Bonds?

Income bonds are normally issued by companies in reorganization (bankruptcy). The issuer promises to repay the principal amount at maturity, but does NOT promise to pay interest unless it has sufficient earnings. Since interest payments are not promised, income bonds trade flat (without accrued interest), sell at a deep discount (well below par), and are considered speculative investments. Despite their name, income bonds (also referred to as adjustment bonds) are not suitable for the typical income-seeking bond investor.

Describe the following type of Money-Market Security: Long-Term CDs?

Long-term or Brokered CDs generally have maturities that range from two to 20 years and are not considered money-market securities. They also may carry additional risks that are not associated with traditional bank-issued CDs, including: - Either limited or potentially no liquidity - The possibility of experiencing a loss of principal if the CD is sold prior to maturity - The potential existence of call features that limit capital appreciation and subject the investor to reinvestment risk - The fact that FDIC insurance may not apply - Unique features that may affect future interest payments such as variable rates, step-ups, and step-downs These long-term CDs are issued by banks and, although sold by broker-dealers, they're insured up to certain limits by the FDIC in the event the issuing bank declares bankruptcy. The amount of FDIC insurance and tax considerations are different depending on whether the CD is purchased in a retirement account. Additionally, if the broker-dealer that sold the brokered CD to the client declares bankruptcy, SIPC coverage will apply since these products are considered securities. Broker-dealers or deposit brokers that offer long-term CDs must ensure that potential customers understand the difference between these products and traditional bank-issued CDs and must also disclose any potential risks that are relevant to the client. Additional disclosures include details of the features that establish the interest rate of the security, such as an index of fixed-income or equity securities.

What's a Money-Market Security?

Money-Market Security= short-term debt instruments with one year or less to maturity. There are a significant number of securities that trade in the money market with issuers including the U.S. government, government agencies, banks, and corporations. There's also a diverse group of participants that utilize the money market including the Federal Reserve Board, banks, securities dealers, and corporations. Money-market transactions provide an avenue for both acquiring money (borrowing) and investing (lending) excess funds for short periods. Typically, the investment period ranges from overnight to a few months, but may be as long as one year.

Define & Describe: Municipal Bonds? Advantages?

Municipal bonds are issued by states, territories, and possessions of the United States, as well as other political subdivisions (e.g., counties, cities, or school districts) and public agencies (e.g., authorities and commissions). Unlike U.S. Treasury securities, these debt instruments carry some level of default risk since municipal bonds are not backed by the U.S. Treasury. Municipal issues are exempt from the filing provisions of the Securities Act of 1933 and are exempt from state and federal registration requirements. However, municipal issues are not exempt from antifraud provisions of any securities law. * For most investors, the primary advantage of municipal bonds is that the interest received is typically exempt from federal tax. * Another advantage is that most states don't tax the interest from bonds that are issued within their borders. For this reason, investors tend to buy in-state bonds to avoid potential federal, state, and (in some cases) local taxes.

In terms of Analyzing Revenue Bonds, describe the Debt Service Coverage?

Nearly all revenue issues pledge a project's net revenue to pay the bondholders their debt service. A net revenue pledge indicates that operating and maintenance expenses are deducted from the gross project revenues before the revenues are applied to debt service. On the other hand, a gross revenue pledge indicates that debt service is paid prior to operating and maintenance expenses being deducted. When analyzing a revenue issue, one of the most important factors is the debt service coverage ratio. This ratio measures the amount of available revenue compared to the amount of revenue needed to satisfy the debt service requirement. For example, a revenue issue shows the following financial data: * Annual Gross Revenue: $8,000,000 * Annual Debt Service: $3,000,000 * Annual Operating and Maintenance Expenses: $2,000,000 To determine the net revenue, subtract operating and maintenance expenses from the gross revenue ($8,000,000 revenues - $2,000,000 O/M expenses = $6,000,000 net revenue). The debt service coverage ratio is then found by dividing the net revenue by the debt service ($6,000,000 net revenue ÷ $3,000,000 debt service). Therefore, the debt service coverage ratio is 2 to 1, which is considered adequate coverage

Define & Describe: Revenue Bonds?

Revenue bonds are issued for either projects or enterprise financings in which the issuer pledges to repay the bondholders using the revenues generated by the financed project. Issuers of revenue bonds may be authorized political entities (e.g., state or local governments), an authority (e.g., the Port Authority of New York and New Jersey), or a commission created to issue bonds for purposes of building and operating a project. Revenue bonds may be used to finance airports, water and sewer systems, bridges, turnpikes, hospitals, and many other facilities. Concessions, tolls, and user fees that are associated with the use of these facilities are used to make interest and principal payments on the bonds. Revenue bonds are generally considered riskier than GO bonds since the generated revenues may prove to be insufficient to fund debt service. Another source of revenue could originate from rental or lease payments. For example, a state may create a non-profit authority to issue revenue bonds in order to build a school. The local government using the school will lease the facility from the authority and the lease payments will be used by the issuer to pay interest and principal. Revenue bonds may be issued when voter approval for general obligation bonds cannot be obtained. Also, revenue bonds may be issued to finance capital projects when statutory or constitutional debt limitations prevent a municipality from issuing general obligation bonds.

Define & Describe: Reverse Convertible Securities? What type of product is this?

Reverse Convertible Securities= type of structured product. Despite their name, these derivative products are NOT like typical corporate bonds; instead, they're a form of structured product. Reverse convertible securities are short-term notes that are issued by banks and broker-dealers. Although often described as debt instruments, they're far more complex than traditional bonds and involve elements of options trading. Reverse convertibles usually pay a coupon rate that's set above prevailing market rates; however, in return, the buyer may be required to take possession of the shares of an underlying asset. In other words, the issuer agrees to pay a higher coupon in return for the ability to repay principal to the investor in the form of a set amount of the underlying asset (rather than in cash). This will happen if the price of the underlying asset drops below a predetermined price (also referred to as the knock-in level). Essentially, the knock-in level is the point at which the security's unique features are triggered. For a reverse convertible, the underlying asset may be an equity security of a company that's unrelated to the issuer, a basket of stocks, or an index.

Describe the following concepts of a 529 College Savings Plans: - Rollover

Rollovers - Under IRS rules, a rollover of a 529 plan is permitted once every rolling 12 months. In rolling over funds from this plan, an investor is moving the funds to another state's plan. Conveniently, there are generally no residency requirements for a 529 plan. A 529 plan may not be rolled over to a Coverdell ESA. In a 529 plan, the donor is not permitted to choose the individual securities to own; instead, the donor chooses among the investment options that are stipulated in the plan. The donor may change the selected investment option no more than twice every 12 months (based on calendar year).

What are the categories that corporate bonds are divided into?

Secured and Unsecured

Define & describe: Secured Bonds? Name the major types of Secure Bonds that companies issue?

Secured: if the issuer falls into bankruptcy, an appointed trustee will take possession of the assets and liquidate them on the bondholders' behalf. Therefore, secured bondholders have a higher degree of protection if the company defaults. 1) Mortgage Bonds 2) Equipment Trust Certificates 3) Collateral Trust Bonds

Describe the Repayment Schedule of a General Obligation (GO) Bond? Serial vs. Term Repayment?

Serial bond issue (one with maturities that are staggered) provides greater flexibility when meeting debt requirements than a term issue (one with a single maturity date). This flexibility is due to the fact that serial maturities may be organized to coincide with expected tax revenues. Future financing also plays a part in general obligation bond analysis. Issuers that borrow early to finance school improvements or new water systems for expected future increases may ultimately be better off than a municipality that waits until it's too late to support an overburdened infrastructure.

Who backs General Obligation (GO) Bonds?

State GO bonds are usually secured by income tax, sales tax, and other taxes collected at the state level. For local jurisdictions, such as counties and cities, the most common source of tax revenue is from levies on real property (ad valorem tax). School taxes are also assessed at the local level and are normally a significant portion of a person's real estate tax assessment.

Who has the authority to issue General Obligation (GO) Bonds?

Statutory Power= a law passed by a state or local government which allows for the issuance of securities. These laws may be amended by legislative action. The constitutional powers to issue general obligation bonds are derived from the state constitution. These statutory and constitutional powers may also limit the amount of debt that an issuer is able to incur. This restriction is referred to as a debt ceiling or the municipality's debt limit.

Differentiate between Step Up vs. Step Down, Long-Term CDs?

Step-down, long-term CD: will offer an investor an interest rate that's initially higher than current market rates. Subsequent interest rates that are paid to investors will be lower and may be adjusted more than once. An RR should disclose to the client that he will not receive the higher interest rate for the life of the CD. Step-up, long-term CD: offers an investor an interest rate that's lower than current market rates for a similar maturity. However, the coupon will be subsequently adjusted upward (stepped-up). A broker-dealer is not required to maintain a secondary market or act as a market maker in a CD that was sold to the client. This will limit the liquidity of the security if the client needs the funds prior to maturity.

Define & Describe: Structured Products?

Structured products are derivative securities that may be linked to a variety of underlying (reference) assets including a stock index, foreign currency, commodity, basket of securities, change in spread between asset classes, single security, or an interest-rate and inflation-linked product. A structured product is typically built around a fixed-income instrument (a note) and a derivative product. While the note pays a specified rate of interest to the investor at defined intervals, the derivative component establishes the amount of payment at maturity. These products are considered a form of corporate debt and are typically created by major financial services institutions. Structured products are usually registered as securities with the SEC; however, clients must receive disclosure that these products are NOT bank deposits and are NOT insured by the Federal Deposit Insurance Corporation (FDIC).

Define & Describe: 529 College Savings Plans?

The Economic Growth and Tax Relief Reconciliation Act of 2001 expanded the federal tax treatment of staterun 529 plans, which are also referred to as municipal fund securities. As with Coverdell ESAs, 529 plans are not retirement accounts; instead, they're savings vehicles created to meet the expenses of higher education. The beneficiary, who may include the donor, is able to be changed in the future. Under federal law, contributions are made with after-tax dollars, but any earnings grow on a tax-deferred basis. If withdrawals are used to pay for higher education, they're considered qualified withdrawals and are tax-free. States that offer 529 plans are responsible for determining the specific plan rules such as allowable contributions, investment options (e.g., mutual funds), and the deductibility of contributions for state tax purposes.

Define & Describe: Alternative Minimum Tax (AMT)?

The alternative minimum tax is a method of calculating a return to ensure that wealthy taxpayers pay at least a minimum amount of tax. When calculating the AMT, various adjustments are made. Some income is added which may not have been subject to regular tax, while some deductions are adjusted downward or eliminated entirely. One of the factors that may trigger an AMT liability is the receipt of interest on private activity municipal bonds, where the proceeds of municipal offerings go to benefit or finance a facility for use by a private business. Since the purchase of a private activity bond could lead to potential AMT liability, the MSRB requires an RR to disclose the bond's details on a confirmation. For any client who is subject to the AMT, an RR must ensure that any recommendations being made are suitable. For example, a client who is in the 35% tax bracket and subject to the AMT is able to purchase an AMT municipal bond yielding 4.70% or a non-AMT municipal bond yielding 4.35%. Which bond will offer the highest after-tax yield? - For the AMT bond, the after-tax yield is calculated as follows: 4.70% x (1.00 - 35%) = 3.05%. - For the non-AMT bond, the after-tax yield is 4.35% (and higher than the AMT bond).

Explain the math for converting Convertible Bonds to Stock?

The bond's conversion price is set at the time it's issued. To determine the conversion ratio (i.e., the number of shares the investor will receive at conversion), the par value of the bond ($1,000) is divided by the conversion price. Conversion Ratio = Par Value of Bond/ Conversion Price For example, if Widget Inc. issues 10% convertible subordinate debentures with a conversion price of $40, the conversion ratio is 25 shares for each bond. Conversion Ratio = $1,000 Par Value/ $40 Conversion Price = 25 shares per bond Prior to trying to solve a computational question regarding convertibles, the first step should be to double-check the conversion price and conversion ratio. An important fact is that if the conversion price is multiplied by the conversion ratio, it should always equal $1,000.

What effect do Unfunded Pension Liabilities have on a municipality?

The existence of unfunded pension liabilities (i.e., the financial reality that the money available may be less than the amount required to pay projected pensions) will have a negative impact on the quality of the issuer's debt.

In terms of Analyzing Revenue Bonds, describe the Flow of Funds?

The flow of funds establishes the order and priority of handling, depositing, and disbursing pledged revenues, as set forth in the bond contract. Generally, when received, pledged revenues are deposited into a general collection account or revenue fund that's established under the bond contract for subsequent disbursement into the other accounts that are established under the bond resolution. These other accounts provide for payment of the costs of debt service, debt service reserve deposits, operation and maintenance costs, renewal and replacement, and other required amounts. Revenues that are generated by the project fill each of the funds to a prescribed level and then flow to the next fund. The flow of funds described below is typical of most revenue bonds. 1) Revenue Fund: the account into which all receipts and income (gross revenues) are deposited and recorded. 2) Operating and Maintenance Fund: the account into which a prorated amount of the revenue is deposited to meet the costs of operating and maintaining the project. Occasionally, there's an excess of funds which allows for the creation of a reserve fund. 3) Debt Service (Bond Service) Fund: the fund into which an amount of revenue is deposited that will be sufficient to pay semiannual interest and maturing principal. 4) Debt Service Reserve Fund: the fund into which revenue is deposited after annual debt service is ensured. These funds are only used if the debt service fund itself is insufficient to meet annual payments. 5) Reserve Maintenance Fund: the fund into which revenue is directed in order meet any unexpected maintenance expenses. 6) Replacement and Renewal Fund: in the event that there's a demand based on an engineer's report, this is the fund into which revenue is deposited to meet new equipment and repair costs. 7) Sinking Fund: the fund into which revenue is accumulated to retire bonds prior to maturity. If there's a mandatory sinking fund provision in the indenture, this fund will receive money prior to the replacement fund. An offering with a mandatory sinking fund will retire a portion of the debt prior to its stated maturity. Since the entire offering will not reach maturity, it will have an average life that's shorter than the stated maturity. 8) Surplus Fund: the fund into which excess money will be placed for use in emergencies.

Describe the following type of Money-Market Security: Federal Funds (Fed Funds)?

The funds that are borrowed overnight on a bank-to-bank basis are referred to as fed funds. This interbank borrowing is usually done to allow a bank to meet the reserve requirement that's set by the Federal Reserve. A bank with excess reserves may lend to a bank that's in need of reserves. This allows the bank with excess reserves to earn interest on funds that would otherwise remain idle. The rate charged on these overnight loans is referred to as the fed funds rate. The rate fluctuates on a daily basis and is a leading indicator of interest-rate trends since it reflects the availability of funds in the system. Although the Federal Reserve doesn't set the fed funds rate, it will attempt to influence the rate through its purchases and sales of government securities in the secondary market. Other short-term interest rates tend to follow changes in fed funds. A bank charges the prime rate when providing loans to a corporation that's among the bank's best credit-rated customers. Other corporations may be charged a higher rate, but the rate will be based on the prime rate. The London Interbank Offered Rate (LIBOR) is the average rate that banks charge each other on loans for London deposits of Eurodollars

How does an issuing municipality's demographics have an effect on the issuance of a General Obligation (GO) Bond?

The make-up of the population of the issuing municipality is an important indicator of a bond's quality. Since many general obligation bonds are dependent on property tax revenues, a growing population is a sign of economic strength; however, a declining population is most likely a sign of a deteriorating tax base. Keep in mind, although a city may lose some of its population to its suburbs, it still may retain its economic strength as a place of employment. The specific industries that constitute a community's employment is another important demographic factor to examine. Diversification of economic activity signals economic strength and also indicates that a municipality is not dependent on any one industry (e.g., computer technology). When analyzing a general obligation issue, a mixture of new, growing companies along with reliable, established companies is a desirable combination.

In terms of Analyzing Revenue Bonds, describe the Feasibility Study?

The municipality must hire a consulting engineer to study the project and present a report to identify whether the project will be able to bring in the necessary revenues. This report examines the need for the proposed project and whether the project is a sound economic investment. Other factors involved in the feasibility study include comparing the cost of using the proposed service to other alternatives available within the project's area to ensure that the project will be competitive and generate revenue. An accounting firm is usually retained to help determine if the revenues will be sufficient to cover expenses and debt service.

Differentiate between a Net Revenue Issue vs. Gross Revenue Issue?

The order of the first three funds is very important. Net Revenue Issue: if net revenues (gross revenues minus operating and maintenance expenses) are pledged to pay debt service. Gross Revenue Issue: if gross revenues are pledged to pay debt service (debt service is paid before the operation and maintenance expenses). (For exam purposes, a net revenue pledge is the assumed flow of funds method.) After the first three funds, the order may vary; however, the following diagram shows the typical flow of funds for a net revenue issue.

How important is the fiscal responsibility of a municipality as well as the analysis of a municipality's financial condition?

The soundness of the budget process is critical because it shows how well a particular governmental entity is managing its fiscal affairs. Fiscal responsibility may be shown in a variety of ways such as balancing the budget, creating rainy-day funds for use in business cycle downturns when fewer tax receipts are collected, having a string of budget surpluses over five years, and reducing expenditures by monitoring the conditions on which services are provided. How well public officials manage in times of economic and financial stress is particularly important to the credit quality of an issuer. A sound financial condition indicates that the governmental entity is able to meet all of its obligations to creditors, employees, taxpayers, suppliers, and others, on a timely basis. Measuring the financial resources that are required to make payments will determine the issuer's financial condition.

Describe the following type of Revenue Bond: Double-Barreled Bonds?

These are backed by a specific revenue source (other than property taxes) as well as the full faith and credit of an issuer with taxing authority (a GO issuer). Essentially, a combination of tax dollars and revenue dollars from the project being constructed will be used to pay the debt service on the bonds.

Describe the following type of Revenue Bond: Utility Revenue Bonds?

These are issued to finance gas, water and sewer, and electric power systems that are owned by a governmental unit. The bonds are normally backed by the user fees that are charged to customers. When assessing the credit risk, important considerations include environmental factors and the growth rate of the area being served by the utility.

Describe the following type of Revenue Bond: Health Care Revenue Bonds?

These are used for the construction of non-profit hospitals and health care facilities. These bonds typically pay their debt service out of gross revenue. With a gross revenue payment process, all revenues received will be used to pay debt service prior to deductions being taken for any costs or expenses. In some cases, the existence of nearby competing facilities will influence the quality of the bonds.

Describe the following type of Revenue Bond: Transportation Bonds?

These are used to finance projects such as bridges, tunnels, toll roads, airports, and transit systems. User fees (e.g., tolls) are used to pay the debt service on these bonds. When analyzing bridge, tunnel, or turnpike bonds, the availability of fuel and the existence of competing non-toll facilities are factors that must be investigated. In addition, for airport revenue bonds, an examination of the level of tourism in an area, fuel costs, and competing airports must be conducted.

Describe the following type of Revenue Bond: Special Tax Bonds?

These bonds are backed by special taxes (e.g., excise taxes on tobacco, liquor, gasoline, hotel/motel stay) for a specific project or purpose, but not by ad valorem taxes. For example, highway bonds that are payable from an excise tax on gasoline are considered special tax bonds.

Describe the following type of Revenue Bond: Moral Obligation Bonds?

These bonds are first secured by the revenues of a project; however, if revenues are insufficient to pay debt service requirements, the state (or a state agency) is morally obligated (but not legally required) to provide the needed funds. Prior to issuing the bonds as moral obligation bonds, the legislative approval of the state government must be obtained.

Describe the following type of Revenue Bond: Special Assessment Bonds?

These bonds are payable only from an assessment on those who directly benefit from the facilities. Examples include bonds issued to develop/improve water and sewer systems, sidewalks, and streets

Describe the following type of Revenue Bond: Escrowed-to-Maturity (ETM) Bonds?

These bonds are secured in the same manner as refunded bonds; however, they don't have a call feature. Due to the fact that they're not callable, these bonds will remain outstanding until their maturity. Similar to advance-refunded bonds, ETM bonds have high credit ratings.

Describe the following type of Revenue Bond: Industrial Development Bonds (IDBs)?

These bonds, also referred to as Industrial Development Revenue bonds (IDRs), are issued by a municipality and secured by a lease agreement with a corporation. The purpose for the offering is to build a facility for a private company. The security's credit rating is based on the corporation's ability to make lease payments since the municipality doesn't back the bonds. An important potential detail is that if the holder of an IDB is a substantial user of the facility, then the federal tax exemption on the interest earned will not apply.

Describe the following type of Revenue Bond: Advance-Refunded Bonds?

These bonds, also referred to as prerefunded or defeased bonds, are outstanding debt obligations that have been collateralized by U.S. government securities. These bonds will usually be paid off on their next available call date and carry high credit ratings.

Describe the following type of Revenue Bond: Education Bonds?

These may be secured by the repayment of loans by students, by the money contained in a fund that was required to be established by the bond's indenture, or by insurance payments made by the state or federal government.

Describe the following type of Revenue Bond: Lease Rental Bonds?

These offerings involve one municipal entity that leases a facility from another. For example, a state building authority may issue bonds to build a college dormitory and then the authority will lease the dorm to the college. The bond issued by the building authority will be paid from the revenues generated through lease payments received from the college. If the lease payment is subject to an annual budgeting process, credit risk is tied to the willingness of the issuer to budget these payments annually.

How is the interest rate/dividend rate of an ARS determined?

Through a Dutch auction process! Before each auction, current ARS investors may request to hold their existing position at the new interest/dividend rate that's established by the auction, hold their existing position at a specified interest/dividend rate, or sell their ARSs. The size of any given auction will depend on how many current ARS investors want to sell and how many want to hold at a certain minimum rate. Essentially, the auction procedures that are set forth in most offering documents allow for a variety of different types of auction orders to be placed with an auction dealer.

When evaluating the risk of default for a General Obligation (GO) Bond, analysts will consider the following factors...?

Unlike U.S. Treasury debt, municipal securities do carry a level of default risk. When evaluating the risk of default for a general obligation bond, analysts will consider the following factors: - The overall economic health of the community including changes in property values, its largest employers, average income, and demographic factors - The tax burden and source of payments - The budgetary structure and financial condition of the issuer - The issuer's existing debt using measures such as debt per capita and overlapping debt

Describe the following type of Money-Market Security: Commercial Paper? By which 2 methods can CP be sold?

When corporations need long-term financing, they issue bonds; but when they need short-term financing, they issue commercial paper. Commercial paper is short-term, unsecured corporate debt which typically matures in 270 days or less. Due to its short maturity, commercial paper is exempt from the registration and prospectus requirements of the Securities Act of 1933. Similar to T-bills, commercial paper is usually issued at a discount; however, some issues are interest bearing. Typically, the minimum denomination is $100,000. Since commercial paper is typically issued by corporations with high credit ratings, it's considered very safe. Standard & Poor's, Fitch, and Moody's issue credit ratings for commercial paper. S&P will assign ratings from A1 (highest) to A3, and Fitch will assign ratings from F1+ (highest) to F3. The highest rating that Moody's will assign to commercial paper is P-1 (also called Prime 1) with intermediate ratings of P-2 and P-3. Speculative commercial paper receives a rating of NP (not prime). There are two methods by which commercial paper may be sold: 1. Directly placed commercial paper - The issuer of commercial paper sells its issues directly to the public using its own sales force. 2. Dealer-placed commercial paper - The issuer sells to a large commercial paper dealers that then resells the issue to the public.

Describe the following type of Secure Bond: Equipment Trust Certificates? What's the collateral for this type of bond?

2) Equipment Trust Certificates - Collateral = Equipment Equipment trust bonds are secured by a specific piece of equipment that's owned by the company and used in its business. The trustee holds legal title to the equipment until the bonds are paid off. These bonds are usually issued by transportation companies and the collateral that's used by these companies is often referred to as rolling stock (i.e., assets that move) and includes railroad cars, airplanes, and trucks.

Describe the following type of Secure Bond: Collateral Trust Bonds? What's the collateral for this type of bond?

3) Collateral Trust Bonds - Collateral = Stocks or Bonds Collateral trust bonds are secured by third-party securities that are owned by the issuer. The securities (stocks and/or bonds of other issuers) are placed in escrow as collateral for the bonds.

Describe the following type of Non-U.S. Market Debt: Eurobond?

As opposed to a Eurodollar bond, a Eurobond is one that's sold in one country, but denominated in the currency of another country. In fact, the issuer, currency, and primary market may all be different. For example, a Russian mayonnaise manufacturer could sell bonds that are denominated in Swiss francs in London. This type of bond, referred to as a foreign pay bond, can be greatly affected by interest-rate movements in the country in which it's denominated.

Define & Describe: Auction Rate Securities?

Auction rate securities (ARSs) are long-term investments that have a short-term twist—the interest rates or dividends they pay are reset at frequent intervals through auctions. Investors who purchase ARSs are typically seeking a cash-like investment that pays a higher yield than available from money-market mutual funds or certificates of deposit. Generally, there are two types of ARSs, bonds with long-term maturities (20 to 30 years) and preferred shares with a cash dividend. Both the interest rate on the bonds and the dividend on the preferred shares will vary based on rates that are set through auctions for a specified short period that's usually measured in days—7, 14, 28, or 35. This is unlike a traditional bond that's issued with an interest rate that's set for its life or preferred stock that specifies the dividend rate for its life. Auction rate bonds are issued by entities such as corporations, municipalities, student loan authorities, and museums, while auction rate preferred shares are issued by closed-end funds.

Describe the following type of Revenue Bond: Certificates of Participation (COPs)?

Certificate of Participation (COP) is a type of lease financing agreement that's usually issued in the form of a tax-exempt municipal revenue bond. COPs have been used as a method of monetizing existing surplus real estate. This financing technique provides long-term funding through a lease that doesn't legally constitute a loan and, therefore, eliminates the need for a public referendum or vote.

Describe the Auction Process for Auction Rate Securities?

Each bid and order size is ranked from the lowest to the highest minimum bid rate. The lowest bid rate at which all of the securities may be sold at par establishes the interest/dividend rate, otherwise referred to as the clearing rate. This is the rate that's paid on the entire issue for the upcoming period. Investors who bid a minimum rate above the clearing rate receive no securities; however, those whose minimum bid rates were at or below the clearing rate receive the clearing rate for the next period. ARS auctions may fail when supply exceeds demand or, put another way, when there are not enough bids to purchase all of the securities being offered for sale in the auction. When an ARS auction fails, existing holders will continue to hold their securities and will generally receive an interest/dividend rate that's set above market rates for the next holding period (up to a maximum that's disclosed in the offering documents). These securities are usually sold as an alternative to other short-term money-market instruments. A member firm must disclose to its clients that if the auction fails, the clients may not have immediate access to their funds. Member firms also have a duty to disclose to their clients all material facts relating to the specific features of the auction rate securities and must evaluate all customers' liquidity needs when recommending this type of product

Summarize the difference between General Obligation Bonds vs. Revenue Bonds?

Gen. Obligation Bonds: Backed by "Full faith & Credit" Revenue Bonds: Backed by specific revenues, *USUALLY IN THE ENTERPRISE FUND* Not Fully backed --> higher interest rates

Describe the concept of Forced Conversion in terms of Convertible Bonds?

Most convertible issues are callable which provides the issuer with the ability to (at its option) redeem the bonds prior to maturity. However, if the call (redemption) price of the bonds is less than the conversion value, the bondholder could be forced to either convert the bond immediately or accept less than its conversion value. This possibility, referred to as forced conversion, may be a disadvantage for investors. For example, Rob owns a corporate bond that's convertible at $40. With the underlying stock currently selling at $50 per share, the corporation calls in the bonds at 105 ($1,050). If Rob asks his RR what action to take, what should she tell him?

Now that we have analyzed both GO and revenue bond issues, let's discuss shorter-term municipal instruments -> Municipal Notes. What are Municipal Notes?

Municipal notes are short-term issues that are normally issued to assist in financing a project. As is true for long-term municipal bonds, short-term municipal notes and commercial paper provide investors with tax-exempt interest. The notes may also be issued to help a municipality manage its cash flow. Municipal notes are interest-bearing securities that ultimately pay interest at maturity.

Describe the following type of Non-U.S. Market Debt: Sovereign Bond?

Sovereign bonds represent debt that's issued by foreign national governments. Although government debt is generally considered quite safe, the credit rating of these bonds is based on the current standing of the issuing government. Ultimately, the issuer's ability to repay the principal and interest is reflected in the bond's yield.

Define & describe: Unsecured Bonds? Name the major types of Unsecure Bonds that companies issue?

Unsecured: When corporate bonds are backed by only the corporation's full faith and credit, these forms of unsecured debt are referred to as notes and debentures. If the issuer defaults, the holders of these securities will have the same claim on the company's assets as any other general creditor—which means before the stockholders, but after secured bondholders. 1. High-Yield (Junk) Bonds 2. Income Bonds 3. Guaranteed Bonds 4. Stepped Coupon Bonds 5. Zero-Coupon Bonds

What are the features we look for when Analyzing Revenue Bonds?

When analyzing a revenue bond issue, it's not necessary to examine the tax base or the tax collection record of the issuer because taxes are not the source of payments to the bondholders. Remember, for revenue bonds, investors are repaid from the cash flows generated by the project that was constructed. Therefore, for revenue bond analysis, a key factor is the comparison of the money being collected from users of a facility to the amount of debt service that must be paid to the bondholders.