Series 7 Chapter 3: Municipal Securities

If an investor in the 27% federal marginal income tax bracket invests in municipal general obligation public purpose bonds nominally yielding 4.5%, what is the tax equivalent yield? A) 0.0616. B) 0.0329. C) 0.1667. D) 0.0572.

Your answer, 0.0329., was incorrect. The correct answer was: 0.0616. The formula for computing tax equivalent yield is: nominal yield divided by (1 − federal marginal income tax rate) .045 / (1 − .27) = 6.16%.

Of the following callable bonds, which confirmation must show yield to call? A) 6% municipal, basis 5.5%, due 2018. B) 6% municipal, par, due 2028. C) 6% municipal, basis 7%, due 2028. D) 6% municipal, basis 6.5%, due 2018.

Your answer, 6% municipal, basis 5.5%, due 2018., was correct!. The only bond priced at a premium is 6% municipal, basis 5.5%, due 2018. On a premium bond, the yield to call will be lower than the yield to maturity.

The most current information on new releases of municipal bonds can be found in A) The Bond Buyer's Guide B) Thomson's Muni Market Monitor (formerly Munifacts) C) "The Bond Buyer" D) the broker/dealer's quote sheets

Your answer, Thomson's Muni Market Monitor (formerly Munifacts), was incorrect. The correct answer was: "The Bond Buyer" "The Bond Buyer" is a daily trade publication containing news about new municipal bond issues.

A dealer that quotes a concession of ½ to another dealer means: A) ½% of the market price. B) ½% of the dealer's price. C) $5 per $1,000 of par. D) a 50% commission split.

Your answer, ½% of the market price., was incorrect. The correct answer was: $5 per $1,000 of par. A concession between broker/dealers on secondary market transactions is a discount from the yield that the broker/dealer is quoting. It is common for a broker/dealer to offer bonds to other broker/dealers at a price less the concession. The net price becomes the purchase price for the buying broker/dealer. If simultaneously sold to a retail account, the markup is from the net price paid. If not simultaneously retailed but held in the broker/dealer's inventory, it is fair for the broker/dealer to market his inventory and mark up from there for retail sale.

A customer's confirmation for a municipal bond callable at par and quoted higher than the nominal yield would show: A) coupon yield. B) yield to maturity (YTM). C) current yield. D) yield to call (YTC).

Your answer, yield to call (YTC)., was incorrect. The correct answer was: yield to maturity (YTM). Because the quoted yield is higher than the nominal yield, the bond is offered at a discount; the lower of YTM or YTC is the bond's yield to maturity.

The indenture of a revenue issue would ordinarily include which of the following covenants? Adequate insurance on the property An increase in property taxes if necessary to service the debt Proper maintenance of the property Statutory debt limits A) II and IV B) II and III C) I and III D) I and II

Your answer, II and III, was incorrect. The correct answer was: I and III The insurance covenant and the maintenance covenant would both be found in the trust indenture of a revenue bond. GO bonds are backed by taxes and have statutory debt limits, not revenue bonds.

Which of the following secures an industrial revenue bond (IDR)? A) Municipal taxes. B) State taxes. C) Corporate net lease payments. D) Trustee guarantees.

Your answer, Municipal taxes., was incorrect. The correct answer was: Corporate net lease payments. Corporate net leases back up IDRs, which means the credit of the bond is as good as the credit of the corporation that signs the net lease.

Which of the following are directly backed by the U.S. government? A) PHAs and NHAs. B) Moral obligation bonds. C) Double-barreled bonds. D) GO bonds.

Your answer, PHAs and NHAs., was correct!. Public Housing Authority and New Housing Authority issues are unique as municipal instruments because they are fully backed by the U.S. government.

All of the following information is included in a municipal bond resolution EXCEPT: A) compensation paid to the underwriters. B) restrictive covenants that are binding on the issuer. C) an authorization to sell the securities. D) any call provisions that allow the issuer to redeem the bonds before their scheduled maturity.

Your answer, compensation paid to the underwriters., was correct!. The bond resolution is the document in which the issuer authorizes the issuance of municipal securities. Among other things, the resolution describes the characteristics of the proposed issue and the issuer's duties to the bondholders. Compensation paid to the underwriters would be found in the official statement.

Which of the following is associated with a process whereby a municipal issuer first appoints and then works with the underwriters who will be establishing the interest rate and offering price for a new municipal bond issue: A) competitive bid. B) Eastern underwriting. C) negotiated underwriting. D) Western underwriting.

Your answer, competitive bid., was incorrect. The correct answer was: negotiated underwriting. In a negotiated underwriting the municipality appoints an underwriting group of investment bankers or broker/dealers to underwrite the offering. The underwrites will then work with the municipal issuer to establish the interest rate and offering price of the new issue to best meet the municipalities needs and in light of current market conditions.

A customer has written a letter of complaint to the dealer. On receipt of the complaint, a municipal securities dealer must first: A) accept the complaint and record the action taken. B) notify the examining regulatory authority. C) refund any money to the customer making the complaint . D) submit to arbitration.

Your answer, submit to arbitration., was incorrect. The correct answer was: accept the complaint and record the action taken. On receipt of a customer complaint, the municipal securities dealer must accept the complaint, record the action taken, put it in a complaint file, and respond. Responses also become part of the complaint file.

Scale in a municipal bond underwriting refers to A) the order of the lowest net interest cost to the municipality. B) yields by maturity. C) price by maturity. D) profit per bond.

Your answer, the order of the lowest net interest cost to the municipality., was incorrect. The correct answer was: yields by maturity. Short maturity bonds usually yield less than do longer maturities. This scale of yields can be converted into dollar prices to allow underwriters to calculate a bid for an issue.

An example of a taxable bond issued by a municipal government is: A) Series EE bonds. B) A tax anticipation note (TAN). C) A Build America Bond (BAB). D) A general obligation bond (GO).

Your answer, A general obligation bond (GO)., was incorrect. The correct answer was: A Build America Bond (BAB). Build America Bonds (BABs) are municipal issues created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing costs to issuing municipalities and stimulate the economy. Bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, but BABs are taxable obligations.

Which of the following is NOT considered when trying to diversify a municipal bond portfolio? A) Geographical location. B) Quality. C) Price. D) Maturity.

Your answer, Geographical location., was incorrect. The correct answer was: Price. One of the purposes of diversifying a municipal bond portfolio is to spread the risk among the portfolio's issues. This can be accomplished by buying bonds of differing maturities, geographical locations, and quality.

Which of the following would be considered in analyzing the credit worthiness of a revenue bond issuer? Per capita debt. Debt service coverage. Management. Debt to assessed valuation. A) III and IV. B) I and II. C) I and IV. D) II and III.

Your answer, I and II., was incorrect. The correct answer was: II and III. Revenue bonds are paid out of revenues from a particular project or facility, not from tax revenue. Therefore, debt service coverage and the personnel in charge of managing the facility are important. Overall debt of the issuer would be important in analyzing a general obligation bond backed by the issuer's full faith and credit.

Which of the following are TRUE of revenue bonds? They are secured by a specific pledge of property. They are a type of general obligation bond. They are not subject to the statutory debt limitations of the issuing jurisdiction. They are analyzed primarily on the project's ability to generate earnings. A) III and IV. B) I and II. C) I and IV. D) II and III.

Your answer, I and II., was incorrect. The correct answer was: III and IV. Revenue bonds are not secured by a specific pledge of property and are not a type of general obligation bond-they are backed by project revenue.

MSRB rules state that a customer confirmation must indicate which of the following? Whether the trade was made as an agency transaction Whether the sale was made from the dealer's inventory The amount of the dealer's markup or markdown The location of the trust indenture. A) II and IV. B) III and IV. C) I and II. D) I and III.

Your answer, I and III., was incorrect. The correct answer was: I and II. MSRB rules require that all confirmations include the firm's capacity in the trade (agent/principal). The amount of the dealer's markup or markdown on a principal trade need not be disclosed. The commission on an agency trade must be disclosed. The official statement must include the location of the trust indenture and a statement that bondholders may review it if they choose.

Which of the following statements regarding a municipal variable rate demand obligation are TRUE? Interest payments are tied to the movements of another specified interest rate. Interest payments are tied to the movements of an underlying stock or index. the coupon rate stays the same for the life of the demand obligation and the price fluctuates. the coupon rate of the bond changes and the price remains stable. A) I and IV. B) I and III. C) II and III. D) II and IV.

Your answer, II and III., was incorrect. The correct answer was: I and IV. A municipal variable rate demand obligation has interest payments tied to the movements of a specified interest rate. Because the coupon rate of the bond changes with the market, the price of the demand obligation tends to remain stable.

The initial confirmation of a when-issued municipal bond contains which of the following? Number of bonds involved in the transaction. Settlement date. Yield to maturity. Total dollar amount due. A) I and II. B) III and IV. C) I and III. D) II and IV.

Your answer, III and IV., was incorrect. The correct answer was: I and III. On a new municipal bond offering, where the customer receives a when-, as-, and if-issued confirmation, the final settlement date is not known; therefore, the amount of accrued interest is unknown (because it is payable up to but not including settlement). Thus, the total dollar amount is unknown because it includes accrued interest. The number of bonds purchased and the yield to maturity (price) are known and must be included on the confirmation.

Which of the following types of municipal bonds is subject to statutory debt limits? A) Special tax bonds. B) General obligation (GO) bonds. C) Industrial development revenue (IDR) bonds. D) Hospital bonds.

Your answer, Industrial development revenue (IDR) bonds., was incorrect. The correct answer was: General obligation (GO) bonds. Only GO bonds, which are backed by the taxing authority of the issuer, are subject to statutory debt limits.

A Western account underwriting of $100 million in municipal bonds is established. A member firm agrees to underwrite 10% of the issue and sells out its allotment of $10 million. However, some of the other firms participating in the deal are unable to sell their full allocation, and $15 million of the bonds remain unsold. What is the member firm's financial obligation? A) 150000. B) $1.5 million. C) Pooled responsibility for $15 million. D) 0.

Your answer, Pooled responsibility for $15 million., was incorrect. The correct answer was: 0. Divided liability in a Western account means that if a member meets its commitment, it has no further liability for unsold bonds.

Under MSRB rules, if a municipal securities dealer has a financial advisory relationship with an issuer, which of the following statements is NOT true? A) The contract must set forth the basis of compensation. B) The contract must be in writing. C) The relationship must be disclosed to purchasing customers. D) The relationship need not be disclosed in communications with the public pertaining to that issuer's securities.

Your answer, The contract must set forth the basis of compensation., was incorrect. The correct answer was: The relationship need not be disclosed in communications with the public pertaining to that issuer's securities. When a financial advisory relationship exists, it must be disclosed to all buyers of that issuer's securities, and in any advertising (communications with the public) relating to that issuer.

A client is trying to decide between a par value corporate bond carrying a coupon rate of 6.25% per year and a par value municipal bond that pays an annual coupon rate of 4.75%. Assuming all other factors are equal and your client is in a 28% marginal income tax bracket, which bond do you tell the client to purchase and why? A) The municipal bond because its equivalent taxable yield is 6.6%. B) The corporate bond because the after-tax yield is 6.25%. C) The municipal bond because its equivalent taxable yield is 6.3%. D) The corporate bond because the after-tax yield is 4.5%.

Your answer, The corporate bond because the after-tax yield is 6.25%., was incorrect. The correct answer was: The municipal bond because its equivalent taxable yield is 6.6%. This is calculated using the tax-equivalent yield formula; Municipal yield / (100% − investors tax bracket) 4.75 / (1 − .28) = 6.6%. By comparison, the 6.6% tax-equivalent yield of the municipal bond is higher than the 6.25% yield of the taxable corporate bond making the municipal bond the higher yielding investment given the investors 28% tax bracket.

A resident of Minnesota is in the 28% federal tax bracket and the 4% state tax bracket. This person must pay both federal and state taxes on: A) Federal Home Loan Bank notes. B) Minneapolis Housing Authority bonds. C) Treasury bills. D) Federal National Mortgage Association pass-throughs.

Your answer, Treasury bills., was incorrect. The correct answer was: Federal National Mortgage Association pass-throughs. The interest income from most U.S. government and agency securities is exempt from state and local, but not federal, taxes. Mortgage-backed securities (such as FNMA and GNMA obligations) are subject to federal, state, and local taxes. The interest on municipal issues (like the Minneapolis housing authority bonds) is exempt from federal taxes and, because this investor is a Minnesota resident, state taxes.

How may a municipal firm retail customer gain access to an MSRB rule book? A) Only by writing the MSRB directly with a specific question involving an MSRB rule. B) Only with the verbal permission of a registered branch manager (sales supervisor). C) Only with the written permission of a principal. D) Upon request to the broker/dealer; no restrictions exist.

Your answer, Upon request to the broker/dealer; no restrictions exist., was correct!. MSRB rules require that an MSRB manual be on-site at all municipal firms. Customers are entitled to see the manual without restriction.

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? A) Yield to the 20-year call at par. B) Yield to the 5-year call at a premium. C) Yield to the 10-year put at par. D) Yield to the 30-year maturity.

Your answer, Yield to the 5-year call at a premium., was incorrect. The correct answer was: Yield to the 30-year maturity. 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 municipal revenue issue's flow of funds statement is contained in the: A) legal opinion. B) notice of sale. C) bond contract. D) agreement among underwriters.

Your answer, bond contract., was correct!. The bond contract describes the nature of the contract and the issuers' duties to bondholders. The bond contract is a more expansive document than a bond resolution. The contract is comprised of the bond resolution (or trust indenture) and other security agreements and laws in force at the time of bond issuance.

With bonds subject to a gross revenue pledge, the first priority will be to pay: A) operation and maintenance . B) the sinking fund. C) the first lien on the property. D) bond interest and principal.

Your answer, bond interest and principal., was correct!. Bonds subject to a gross revenue pledge (gross lien revenue bonds) are backed by the gross revenues of the facility (meaning revenues before expenses). In this case, the first money disbursed is for payment of interest and principal. However, most revenue bonds only pledge net revenues to pay off revenue bonds. In the more common net revenue pledge, the first priority is operation and maintenance; the second priority is interest and principal.

An investor in a high income tax bracket owns a number of municipal bonds and wants to add some to a 401k plan he participates in and perhaps his IRA. As a registered representative, you would advise that this is A) not suitable because the interest payments from municipal bonds are tax-free already and have no place in a tax-advantaged (tax-deferred) account such as a 401k plan or IRA B) not suitable because the investor already owns municipal bonds, and this would be a duplication of the same asset class in his tax-advantaged accounts C) suitable because the investor already understands the advantages of owning tax-free interest paying instruments without any further suitability qualifications needed D) suitable due to his high income tax bracket

Your answer, not suitable because the investor already owns municipal bonds, and this would be a duplication of the same asset class in his tax-advantaged accounts, was incorrect. The correct answer was: not suitable because the interest payments from municipal bonds are tax-free already and have no place in a tax-advantaged (tax-deferred) account such as a 401k plan or IRA While municipal bonds can be suitable for those in higher income tax brackets, they have no place in tax-advantaged (tax-deferred) accounts such as 401k plans or IRAs because the interest paid is already tax free.

If a municipal bond rated BBB is pre-refunded, all of the following statements are true EXCEPT A) funds required to meet debt servicing have been set aside in escrow B) the issue is now backed by U.S. government securities C) the rating of the issue will increase D) the marketability of the issue will decrease

Your answer, the issue is now backed by U.S. government securities, was incorrect. The correct answer was: the marketability of the issue will decrease 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 portion of a municipal bond underwriting spread that remains after the syndicate manager subtracts the management fee is: A) the concession. B) the total spread. C) the additional takedown. D) the total takedown.

Your answer, the total spread., was incorrect. The correct answer was: the total takedown. The total takedown is that portion of the municipal underwriting spread that remains after the underwriting manager takes the management fee. The total takedown consists of the additional takedown and the concession.

For a new issue municipal syndicate account, settlement of the account must occur: A) within 30 calendar days after the issuer delivers the securities to the syndicate. B) when the last bond is sold with no time limit imposed. C) within 1 year after the issuer delivers the securities to the syndicate. D) as soon as dealers who are not members of the syndicate request a bond.

Your answer, within 30 calendar days after the issuer delivers the securities to the syndicate., was correct!. The maximum length of time a new issue municipal bond syndicate can exist is 30 calendar days after the issuer delivers the securities to the syndicate. At that time the account must be settled and allocation of unsold bonds be determined in accordance with each members original allocation and whether the syndicate was set up as divided (western) or undivided (eastern).