Unit 5: Questions

Which of the following statements about municipal brokers' brokers is not true? A) They perform trades on a principal basis only. B) They perform specialized trades for institutions. C) They do not perform retail trades with individual investors. D) They do not maintain inventories.

A A broker's broker does not maintain an inventory of bonds. Therefore, they do not act as principals; they act as agents only in trades between dealers or institutions. They do not do retail business. LO 5.e

Municipal brokers' brokers deal with all of the following except A) individuals. B) bank dealers. C) municipal dealers. D) institutions.

A As the term suggests, a municipal broker's broker deals with other dealers and institutions, not with the general public. LO 5.e

Which of the following statements regarding revenue bonds issued by a state or municipality is true? A) Interest will be paid only if the enterprise owned and operated by the state or municipality has sufficient earnings to cover the interest payments or the debt service reserve. B) Interest and principal payment is guaranteed. C) The bonds carry an unqualified promise to pay interest and principal backed by the power of the issuer to levy taxes. D) Interest and principal payment is backed by the full faith and credit of the issuer.

A Because revenue bonds are not backed by the full faith and credit of the municipality that issues them, the earnings of the revenue-producing project must be large enough to cover the interest and principal payments. LO 5.c

Municipal securities broker's brokers A) execute trades for other municipal securities broker-dealers. B) participate in selling groups on new municipal issues. C) bid on negotiated underwritings. D) share the names of their clients with the executing dealers.

A Broker's brokers are what the term implies. They represent other firms and use their connections to facilitate trades, usually with institutions. They never take an inventory position or get involved with underwriting new issues. One of their key roles is preserving the anonymity of their clients. LO 5.e

Having a five-year-old child, a couple wants to begin saving for her college education. They can currently budget $350 per month toward the goal. They know that college costs 13 years in the future need to be factored, but they are not too comfortable with market risk. Which would best align with their profile? A) 529 prepaid tuition plan B) Money market mutual fund C) Variable annuity plan D) Coverdell Education Savings Account (ESA)

A Coverdell ESAs and Section 529 plans are the only choices here specifically associated with saving for education. Because the Coverdell ESA can only accept $2,000 per child, per year, and the couple can currently invest more than twice that amount, the 529 plan is the better choice. Additionally, being concerned about inflation and not comfortable with market risk, investing in a 529 prepaid tuition plan enables them to purchase tomorrow's tuition at today's prices. LO 5.h

An example of overlapping debt would be a school district and A) county general debt. B) a water pollution control facility. C) corporate debt of the county's largest employer. D) a local utility power plant.

A Do not combine revenue bonds with general obligation bonds (GOs) to determine overlapping debt. Overlapping debt occurs in real estate taxing situations. Only GOs are backed by real estate taxes. LO 5.c

An investor buys a municipal bond at a discount. The bond carries a 3% coupon. At maturity, the bond will pay the face amount to the holder of the bond on the maturity date. In the meantime, the IRS requires accretion of the discount. That accretion is tax-exempt income when the bond is A) an original issue discount bond. B) a general obligation bond. C) a bond issued at par, but purchased in the secondary market at a discount. D) a bond purchased in the secondary market at a discount.

A If the discount is an original issue discount (OID), the annual accretion is not taxable. An OID means that the bond's issuance price in the primary market was below par (a discount). As an OID, the annual accretion is considered part of the interest being paid by the issuer and that is why it is tax exempt. However, if the discounted transaction were in the secondary market, then the annual accretion would be taxable as interest income. That does not affect the tax-exempt status of the coupon interest paid. It is highly unlikely that your exam will ask about the tax treatment of the accretion when a secondary market purchase of an OID municipal bond occurs at a price above or below its accreted value. The exam could ask about capital gain or loss, but we do not expect a question about figuring the tax on the accretion in this unusual case. LO 5.g

An investor has losses on the sale of municipal bonds. Which of the following, for tax purposes, is true? A) The losses can be applied against the gains on the sale of any other security. B) The losses can be applied only against gains on the sale of other municipal bonds. C) The losses can be applied only against gains on the sale of other debt instruments (bonds). D) No losses on municipal bonds can be applied against gains on sales of any securities.

A Losses on the sale of one investment can generally be deducted against gains on the sale of any other investment. LO 5.g

A violation of MSRB rules would occur if A) a representative gave a gift to an associated person of another broker-dealer that was valued just under $250. B) an associated person held a joint account with a spouse. C) a registered representative (RR) recommended geographic diversification to limit risk. D) a representative made a recommendation to a customer after gathering information about the customer's financial status, tax status, investment objectives, and other holdings.

A MSRB rules limit gift giving to a maximum of $100 per person per year in cash or value. The $250 is the amount a municipal finance professional (MFP) can make as a political contribution to a candidate for whom the MFP is eligible to vote. LO 5.j

Under Municipal Securities Rulemaking Board (MSRB) rules regarding municipal securities, a control relationship exists when I. officers or employees of a broker-dealer hold positions of authority over the municipal issuer. II. officials of the municipal issuer hold policymaking positions at the broker-dealer. III. the municipal issuer is a public finance client of the broker-dealer. IV. an employee of the broker-dealer lives in the issuer's municipality. A) I and II B) III and IV C) II and III D) I and III

A MSRB rules state that a control relationship exists when a broker-dealer controls, is controlled by, or is under common control with the issuer of the security. LO 5.j

If an investor is in the highest federal income tax bracket and is subject to the alternative minimum tax (AMT), which of the following securities should an agent recommend? A) General obligation (GO) bond B) Industrial revenue bond C) Treasury bond D) Corporate bond

A Municipal bonds are suitable for the portfolio of an investor who is in a high tax bracket because the interest is exempt from federal income tax. A GO bond is a better recommendation than an industrial revenue bond because the interest on industrial revenue bonds is likely subject to the AMT. LO 5.g

Your firm is interested in submitting a bid on a forthcoming general obligation municipal bond issue. Your firm could obtain the appropriate bid worksheets through a service provided by A) The Bond Buyer. B) The Wall Street Journal. C) the Municipal Securities Rulemaking Board. D) Standard & Poor's.

A Official notices of sale announcing the offering of municipal issues to competitive bidders are published in The Bond Buyer. The Bond Buyer offers a service to subscribers (called the New Issue Worksheet and Record Service) that summarizes each notice. It provides information about new issues put up for bid and worksheets for underwriters to determine yields and prices when bidding. LO 5.i

The Bond Buyer compiles several indexes of municipal bonds. Which of the following is limited to bonds with the highest ratings? A) The 11 Bond Index B) The 40 Bond Index C) The 20 Bond Index D) The Revdex 25

A The 11 Bond Index takes the highest rated (AA or better) bonds from the 20 Bond Index of bonds with A ratings or better. LO 5.i

Alternative minimum tax (AMT) A) is assessed against high annual income earners and disallows some deductions and exemptions used to calculate adjusted gross income. B) is assessed against low annual income earners and allows special deductions for them to be taken. C) is assessed against all self-employed individuals. D) is assessed against high annual income earners and gives them special deductions that lower income earners do not get.

A The AMT is assessed against high annual income earners. When calculating adjusted gross income, some deductions and exemptions are disallowed, resulting in a higher taxable adjusted gross income. LO 5.g

Which of the following may only be accomplished after applying the additional bonds test for a revenue bond? A) Issuing new bonds with an equal lien on the project's revenues B) Spending revenues already allocated for project expansion C) Prerefunding an outstanding bond issue D) Increasing the project's user charges

A The additional bonds test must be met under the provisions of a revenue bond indenture before additional bonds with an equal lien on project revenues can be issued. The conditions under which additional bonds may be issued are specified in the bond indenture. This is an open-end covenant. LO 5.d

All of the following would be found in a bond resolution for a new municipal issue except A) the costs to be incurred by the issuer in connection with the offering. B) covenants to which the issuer must adhere. C) the issuer's obligations to bondholders. D) a description of the issue.

A The bond resolution (or the bond contract) spells out the characteristics of the issue (maturities, call features, etc.), the issuer's responsibilities to bondholders, and any restrictive covenants to which the issuer must adhere. Costs to be incurred by the issuer have no impact on bondholders. LO 5.c

When creating a diversified municipal bond portfolio, all of the following should be considered except A) the denomination of the bonds included in the portfolio. B) the geographic location of the issuer. C) the source of funds backing the bonds. D) the credit rating.

A The denomination of the bonds in a portfolio is not relevant to diversification. What difference does it make if the bonds carry a denomination of $1,000 or of $5,000? We diversify by quality by including bonds with different ratings. We recognize that the United States is a large country with some geographic areas outperforming others. That is why we diversify the portfolio by including bonds from different states. Another way to diversify the portfolio is by including GO bonds and revenue bonds. LO 5.e

When purchasing a new issue, investors generally receive a disclosure document. This document contains the essential information (material facts) necessary to make an investment decision. An investor purchasing which of the following new issues would not receive a prospectus? A) A municipal revenue bond B) A unit investment trust C) A closed-end investment company D) A mutual fund

A The disclosure document for a municipal bond, revenue, or general obligation is the official statement. The difference in terminology—prospectus or official statement—is frequently tested. LO 5.b

Which of the following statements describing Section 529 plans is true? A) The maximum lifetime contribution varies from state to state. B) They can only be opened for children under the age of 18. C) Most state college savings plans require either the owner or the beneficiary of the plan to be a state resident. D) The fees associated with them are generally the same from state to state.

A The features of Section 529 plans, including their contribution limits and fees, vary widely from state to state. Section 529 plans have no age limits as to participation; they are open to both children and adults who plan to attend college or graduate school. For college savings plans, there is no state residency requirement for either owners or beneficiaries of Section 529 plans. LO 5.h

A municipal bond underwriter looking in The Bond Buyer would recognize the percentage of new issues sold versus new issues offered for sale the prior week as A) the acceptance or placement ratio. B) the general obligation (GO) index. C) the visible supply. D) the revenue bond index.

A The placement ratio, also known as the acceptance ratio, is compiled weekly and reflects the municipal bonds sold divided by the municipal bonds offered in the previous week. LO 5.i

A qualified legal opinion issued for a municipal bond underwriting means that A) the legal opinion is qualified with restrictions and conditions. B) the bond counsel is considered competent. C) the revenue bond issue has certain debt limitations. D) the bond attorney is qualified to express her opinion on the bond.

A The word qualified describes the legal opinion, not the attorney (or bond counsel) who issued it. A qualified legal opinion is one in which the bond counsel expresses reservations about conditions that may affect the bond's status. An unqualified legal opinion is rendered without restriction or condition. LO 5.a

The City of Podunk has an outstanding 25-year maturity issue that is callable in seven years. It has prerefunded the issue and established an escrow account containing the proper government securities with face amounts and maturities approximating the call provisions of the original issue. In quoting the original issue, which of the following must be used? A) Yield to call B) Yield to maturity C) Current yield D) The lower of the yield to call or the yield to maturity

A When a bond issue is prerefunded, the issuer is going to redeem the bond on the first call date. The yield must be quoted to call. LO 5.j

Which of the following underwriting arrangements is associated with an invitation, typically found in The Bond Buyer, directed at investment bankers and broker-dealers, intended to solicit interest in underwriting a new municipal issue? A) Competitive bid B) Negotiated C) All or none D) Best efforts

A With a competitive bid underwriting, a municipality publishes invitations to bid in The Bond Buyer or another municipal bond publication. Investment bankers and broker-dealers interested in underwriting the new municipal issue would respond to the invitation to bid. LO 5.b

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 entire allotment of $10 million. However, some of the other firms participating in the underwriting are unable to sell their full allocation, and $15 million of the bonds remain unsold. What is the financial obligation of the underwriting firm who sold their entire allotment? A) $1.5 million B) $0 C) $150,000 D) Pooled responsibility for $15 million

B

A corporate bond pays interest on a J/J 15 schedule. An investor purchasing these bonds on Friday, April 17, would pay accrued interest for A) 95 days. B) 96 days. C) 91 days. D) 92 days.

B A J/J 15 schedule means the bond pays interest on January and July 15. Corporate (and municipal) bonds count each month as 30 days. As with all bonds, the accrued interest is paid from the previous interest payment date up to but not including the settlement date. A trade made on Friday the 17th settles the following Tuesday (T+2), April 21. The previous interest payment was January 15. Do the following simple calculation: Settlement date of 4/21 Minus last interest - 1/15 Result is 3/06, or 3 months plus 6 days With each month being 30 days, the answer is 90 + 6 or 96 days. LO 5.f

Which of the following is a double-barreled bond? A) Anticipation note B) Hospital bond backed by revenues and taxes C) General obligation bond to construct a new grade school D) New Housing Authority (NHA) bond

B A double-barreled bond is backed by a defined source of revenue other than property taxes, as well as the full faith and credit of an issuer with taxing authority. NHA bonds are not double-barreled. If rental income from the housing cannot meet servicing costs, the shortfall is covered by the federal government. To be double-barreled, the issue must be backed by more than one municipal source. LO 5.c

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) II and III B) I and IV C) II and IV D) I and III

B 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. LO 5.c

One of the benefits of adding a sinking fund provision to a municipal bond issue is that the bond will generally A) have a longer maturity. B) be issued with an interest rate lower than without the sinking fund. C) receive more favorable tax treatment. D) be issued without a call provision.

B Adding a sinking fund provision to a bond issue invariably results in a higher rating for the security. The fact that money is put aside to repay the principal on a regular basis offers greater safety. A higher rating results in a lower coupon, not a higher one. After all, the higher the rating, the lower the risk, and that means the issuer is able to borrow at a lower cost. Although the sinking fund itself does not change the maturity date, having a sinking fund enables the issuer to use partial calls to redeem the bond ahead of the final maturity date. A sinking fund has nothing to do with tax treatment. LO 5.a

An inherent risk associated with auction rate securities (ARS) is the potential to have A) a Dutch auction. B) a failed auction. C) a clearing rate. D) a reset rate.

B An inherent risk associated with ARS is the potential for a failed auction. These can occur due to a lack of demand, resulting in no bids being submitted when it is time to reset the rate. ARS use a Dutch auction method to reset the clearing rate paid in the upcoming period. LO 5.c

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

B BABs are municipal issues created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing the cost of issuing municipalities and to stimulate the economy. Bonds to fund municipal projects have traditionally been sold in the tax-exempt arena, but BABs are taxable obligations. LO 5.c

The City of Concord has floated a new bond issue to expand the public library. Concord has arranged for these bonds to be insured. If Concord defaults on these bonds for any reason, the insurance company will A) immediately pay the bondholders the principal and the interest that has accrued thus far. B) pay the bondholders the principal and interest as scheduled. C) demand additional premiums to maintain the coverage. D) pay the city treasurer the principal so that the city has the funds to pay the principal and interest to the bondholders.

B Bond insurance is a feature offered by many municipal bonds. The effect of the bond insurance is that both interest and principal will be paid as scheduled, over time, through the life of the bond. Payments are made to the bondholders by the insurance company. LO 5.e

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

B 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. LO 5.c

When the issuer of an insured municipal bond defaults, what does the insurance company do? A) Both principal and remaining interest payments are paid immediately to the bondholder. B) Both principal and interest are returned over the remaining term of the bond. C) Only the principal is returned with the bondholder losing the interest. D) Principal is returned immediately, and the interest is paid out based upon the normal schedule.

B Both interest and principal are paid as scheduled over time through the life of the bond. The idea is that the bondholder should not see a problem. The insurer will just take up the liability and run with it without missing a beat. LO 5.e

The interest from which of the following bonds is subject to federal income tax? State of Nebraska City of Duluth Treasury notes Federal National Mortgage Association (FNMA) A) I and II B) III and IV C) I and III D) II and IV

B Direct federal debt, such as a Treasury note, is subject to federal income tax but exempt from state tax. FNMA bonds are subject to federal, state, and local taxes. State and city bonds, being municipals, are exempt from federal income tax. LO 5.g

The interest on which of the following municipal securities may be considered preference income for alternative minimum tax purposes? A) Original issue discount bonds B) Private purpose bonds C) PHAs D) TANs

B Interest on private activity municipal bonds is included in the taxable income of an investor who is subject to the alternative minimum tax. LO 5.g

While acting in a financial advisory capacity to a municipal issuer, a municipal securities dealer wants to be part of a syndicate in the underwriting of one of the issuer's new bonds. Which of the following statements regarding this situation is true? A) The dealer would be allowed to participate and collect fees for both advisory and underwriting services supplied. B) This is recognized by the MSRB as a potential conflict of interest; municipal rules generally prohibit a broker-dealer from acting in both capacities. C) Only an approval by the SEC could allow the broker-dealer to function in both capacities. D) The dealer must obtain the MSRB's written approval before signing the syndicate letter.

B MSRB rules to eliminate conflicts of interest generally prohibit broker-dealers from acting in both an advisory capacity to an issuer and as an underwriter of the issuer's bonds. The MSRB rules do address certain allowable exceptions, but neither MSRB written approval nor the approval of the SEC would be required should the conditions of the allowable exceptions exist. LO 5.j

Which of the following statements regarding municipal securities quotations are true? A quotation can be an indication of interest. A quotation cannot be an indication of interest. A quotation can be a one-sided request for a bid or offer (bids wanted and offers wanted). A quotation cannot be a one-sided request for a bid or offer (bids wanted and offers wanted). A) I and IV B) I and III C) II and III D) II and IV

B Municipal Securities Rulemaking Board rules pertaining to quotations cover all bona fide bids and offers, including one-sided requests for bids wanted and offers wanted, which are considered indications of interest. LO 5.a

Which of the following regarding revenue bonds are true? 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) I and II B) III and IV C) II and III D) I and IV

B 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. LO 5.c

The call provisions of a municipal issue would be detailed most completely in A) the legal opinion. B) the bond resolution. C) the official notice of sale. D) The Bond Buyer.

B The bond resolution is the document that authorizes the issuance of a municipal bond. The resolution also describes the proposed issue's features and the issuer's responsibilities to its bondholders. LO 5.a

All of the following statements regarding a municipality's debt limit are true except A) that unlimited general obligation bonds may be issued when a community's taxing power is not restricted by statutory provisions. B) that the debt limit is the maximum amount a municipality can borrow in any one year. C) that the purpose of debt limits is to protect taxpayers from excessive taxes. D) that revenue bonds are not affected by statutory limitations.

B The debt limit is the maximum amount of debt a municipality can have. LO 5.d

One of your customers is in the 37% federal income tax bracket. The customer prefers purchasing corporate bonds over municipal bonds because the corporation's financials are much easier to understand. On the customer's next purchase, the instructions are to find a corporate bond that will yield the same after-tax return as would be received from a municipal bond with a 3.20 coupon. The bond you suggest must have a coupon of A) 8.65%. B) 5.08%. C) 4.38%. D) 3.20%.

B This is a tax-equivalent yield question. The interest paid on a corporate bond is taxable, while that of the municipal bond is tax free. The formula is: The coupon of the municipal bond divided by (100% − tax bracket). In our question, that would be 3.20% divided by 63%, or 5.08% LO 5.g

Which of the following statements regarding Section 529 education savings plans are true? I. Contributions are considered gifts under federal law. II. Contributions are tax-deductible under federal law. III. Earnings generated are taxable each year. IV. Earnings generated are tax-deferred. A) II and III B) I and IV C) II and IV D) I and III

B Under federal law, contributions made into Section 529 plans are considered gifts and are not deductible at the federal level. Furthermore, earnings generated each year are tax-deferred and, on withdrawal, are tax free at the federal level if used for qualified education expenses. LO 5.h

If a corporation is in bankruptcy or is forced to liquidate, when do the preferred shareholders receive payment? A) Before unsecured creditors (e.g., general creditors, including debenture holders) B) Before common stockholders C) Before subordinated debt holders D) Before secured creditors (e.g., mortgage bonds, equipment trust certificates, collateral trust bonds)

B When a corporation is unable to meet its obligations, it is usually forced to liquidate. Preferred shareholders are paid before common shareholders. After a formal bankruptcy filing, the order from first to last is secured creditors (e.g., mortgage bonds, equipment trust certificates, collateral trust bonds), unsecured creditors (e.g., general creditors, including debenture holders), subordinated debt holders, preferred stockholders, and common stockholders. LO 5.b

An investor purchased a municipal bond at par for $10,000 on February 15, 2022. On August 15, 2022, if the investor sells the bond for $10,500, for tax purposes, the $500 profit is recognized as A) interest income. B) a short-term capital gain. C) a long-term capital gain. D) a tax-free capital gain.

B When municipal bonds are purchased at par and subsequently sold at a higher price, the resulting profit is taxed as a capital gain. Only interest income from municipal bonds is exempt from taxation. This gain is not classified as long-term because the investor did not hold the bond for more than one year. LO 5.g

An investor in a high-income tax bracket owns a number of municipal bonds and wants to add some to a 401(k) plan he participates in and perhaps his IRA. As a registered representative, you would advise that this is A) 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. B) 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 401(k) plan or IRA. 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.

B 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 401(k) plans or IRAs because the interest paid is already tax free. LO 5.g

A statutory debt limitation restricts a municipality's authority regarding A) insuring bond issues. B) selling revenue bonds. C) issuing general obligation (GO) bonds. D) raising tax rates.

C A municipality may be limited by statute regarding the amount of GO debt it may incur. LO 5.d

An investor receiving a quote of 102 for a municipal security is probably interested in A) a bond anticipation note. B) a general obligation bond. C) a term bond. D) a serial bond.

C A quote of 102 is referred to as a dollar quote ($1,020) rather than a yield quote. The most common dollar bonds are those with a term maturity. The other choices are most often quoted on a yield basis rather than a price basis. LO 5.a

A variable-rate municipal bond investment's main advantage is that A) it is noncallable. B) it is likely to increase in value. C) its price should remain relatively stable. D) its interest is exempt from all taxes.

C A variable-rate bond has no fixed coupon rate. The coupon is tied to a market rate (e.g., T-bond yields) and subject to change at regular intervals. Because the interest paid reflects changes in overall interest rates, the bond price remains relatively close to its par value. Its coupon is always representative of the current market rate. As rates rise, the coupon is adjusted upward. As rates fall, the coupon is adjusted downward. LO 5.c

The City of Concord has floated a new bond issue to expand the public library. Concord has arranged for these bonds to be insured. If Concord defaults on these bonds for any reason, the insurance company will A) immediately pay the bondholders the principal and the interest that has accrued thus far. B) demand additional premiums to maintain the coverage. C) pay the bondholders the principal and interest as scheduled. D) pay the city treasurer the principal so that the city has the funds to pay the principal and interest to the bondholders.

C Bond insurance is a feature offered by many municipal bonds. The effect of the bond insurance is that both interest and principal will be paid as scheduled, over time, through the life of the bond. Payments are made to the bondholders by the insurance company. LO 5.e

If industrial development bonds are called because of condemnation, this would be covered under which of the following clauses in the bond indenture? A) Refunding B) Defeasance C) Catastrophe D) Refinancing

C Condemnation is considered a catastrophe and only applies to revenue bonds. LO 5.c

Which of the following statements are true? Build America Bonds (BABs) are tax exempt at all levels. Direct-payment BABs provide the municipal issuer with payments from the U.S. Treasury. BABs are issued by the U.S. Treasury. Tax credit or issuer BABs provide the municipal bondholder with a federal income tax credit. A) I and IV B) II and III C) II and IV D) I and III

C Created under the Economic Recovery and Reinvestment Act of 2009 to assist in reducing costs to issuing municipalities and to stimulate the economy, BABs are taxable municipal securities. There are two types: direct payment BABs that provide the municipal issuer with payments from the U.S. Treasury and tax credit or issuer BABs that provide the bondholder with a federal income tax credit. LO 5.c

Which of the following are considered sources of debt service for general obligation (GO) bonds? I. Tolls on roads II. Real estate taxes III. Revenue generated by a hospital IV. Liquor license fees A) I and IV B) I and III C) II and IV D) II and III

C General revenues of the municipality, such as real estate taxes or licensing fees, may be used to pay the debt service on a GO bond. Usage revenue, such as that generated from toll roads or hospitals, would be associated with funding revenue bonds. LO 5.d

Whether funds should be allocated to support the debt service on a moral obligation bond in default is usually determined by A) the courts. B) the state governor. C) the state legislature. D) the trustee.

C Legislation authorizing the issuance of moral obligation securities usually grants the state legislature the authority to apportion money to support debt service payments on such securities but does not legally require the legislature to do so. This is called legislative apportionment. LO 5.a

A legal opinion issued for a municipal bond covers which of the following? I. Feasibility of public works projects II. Creditworthiness of the issuing municipality III. Tax status of the municipal debt IV. Constitutionality and legality of the municipal debt A) I and II B) II and III C) III and IV D) I and IV

C Municipal securities are reviewed by specialized lawyers who render a legal opinion. The opinion covers two main issues: constitutionality (i.e., it ensures that the bonds are legal, valid, and binding obligations of the issuer) and verification of the tax status of the debt (i.e., interest on the bonds is exempt from federal income taxes as well as state and local taxes in some cases). LO 5.a

The manager of ABC Municipal Securities is interested in bidding on some general obligation bond issues that will be available in the coming months. Where would the manager find information about these forthcoming issues? A) Electronic Municipal Market Access (EMMA) B) Standard & Poor's Bond Guide C) The Bond Buyer D) The Washington Post

C Municipalities publish their official notices of sale soliciting bids from interested parties in The Bond Buyer. The notice gives the details of the bonds put up for bid and how to bid on the issue. The S&P Bond Guide gives details of outstanding issues and their ratings. The EMMA is an online site primarily for retail nonprofessional investors. LO 5.b

The date on which interest will begin accruing on a new municipal issue is A) the filing date. B) the closing date. C) the dated date. D) the delivery date.

C New issues of municipal bonds begin accruing interest as of the dated date. LO 5.f

Which of the following municipal securities are backed by the full faith and credit of the U.S. government? A) Tax assessment bonds (TAs) B) Industrial revenue bonds (IRBs) C) Public Housing Authority bonds (PHAs) D) General obligation bonds (GOs)

C PHA bonds are backed by the full faith of the U.S. government, which guarantees rent payments on these low-income properties. LO 5.c

Municipal Securities Rulemaking Board (MSRB) rules for NYSE member firms are enforced by A) the MSRB. B) the SEC. C) FINRA. D) the NYSE.

C The board's rules are enforced by FINRA for securities firms. The MSRB has rulemaking authority but no enforcement or examination authority. LO 5.j

An investor purchased 10 GO bonds at a discount of 2 points per bond. The bonds mature in 10 years. After holding the bonds for 5 years, they were sold at par. For tax purposes, the investor has A) a $100 loss. B) no gain and no loss. C) a $100 gain. D) a $50 gain.

C The cost per bond is $980. The accretion amount each year is $20. $20 ÷ 10 years = $2 per year. $2 per year × 5 years = $10 per bond accretion, making the adjusted cost basis $990 per bond. When the bonds are sold at par ($1,000), there is a profit of $10 per bond × 10 bonds, which equals a $100 gain. LO 5.f

The City of Columbus issued a 20-year general obligation bond at a price of 50. An original purchaser sold the bond at 75 after holding it for 7 years. For tax purposes, that sale generated A) a $25 capital gain. B) no gain or loss. C) a $75 capital gain. D) a $250 capital gain.

C The customer has realized a capital gain of $75. Original issue discount bonds must accrete the discount over the life of the bond. In this example, the amount of the discount (par value minus purchase price) is $500 ($1,000 − $500 = $500). The discount divided by the number of years to maturity determines the annual accretion added to the cost basis. In this question, the annual accretion is $25 ($500 ÷ 20 = $25). The adjusted cost basis would be the original purchase price ($500) plus seven years of accretion (7 × $25 = $175) for a total of $675. Because the proceeds of the sale were $750, the customer has realized a capital gain of $75 ($750 − $675 = $75). LO 5.g

Investor information about the financial condition of a municipal issuer is most likely found in A) the official notice of sale. B) the legal opinion. C) the official statement. D) The Bond Buyer.

C The official statement, which is the disclosure document used in new municipal offerings, will describe the issue's financial condition in detail. LO 5.b

If the State of Texas has solicited bids for a proposed municipal bond offering, the underwriters for that offering would be the syndicate that would A) generate the most proceeds for the State of Texas. B) sell the issue at the lowest price. C) sell the issue at the lowest net interest cost to the State of Texas. D) sell the issue at the highest price.

C The syndicate manager that offers the lowest net interest cost to the State of Texas will be awarded the bid. Once the State of Texas decides how much money it must raise, the question is how much this issue will cost in net interest during its entire life. Keeping it simple, the borrower (the state) is looking to borrow money at the lowest rate. LO 5.b

An investor anticipating a rise in interest rates would likely purchase A) bonds issued by the U.S. Treasury. B) callable bonds. C) variable-rate demand obligations or reset bonds. D) corporate bonds.

C When interest rates increase, the market price of all fixed-income securities declines. In the case of variable-rate or reset bonds, the interest rate on those is adjusted based on the movements of market interest rates. As a result, when interest rates increase, the rate paid by the variable rate security increases as well. This tends to keep the market price stable rather than declining and it provides increased income to the investor. A callable bond works to the issuer's advantage when interest rates fall but offers no added benefit to an investor when interest rates rise. Corporate or government-issued bonds offer no advantage for an investor anticipating a rise in interest rates because with fixed interest rates, their price will decline. LO 5.d

Which of the following statements regarding the suitability of municipal bonds are true? I. The tax-free interest payments make them more suitable for those in higher tax brackets. II. The tax-free interest payments make them more suitable for those in lower tax brackets. III. The tax-free interest is why municipal bonds are not considered suitable investments to be included in one's retirement account, such as an IRA. IV. The tax-free interest is one reason why municipal bonds are considered suitable investments to be included in one's retirement account, such as an IRA. A) II and IV B) II and III C) I and IV D) I and III

D Tax-free interest payments are more suitable for those for whom the tax advantage has the most impact. That would be those in higher tax brackets, who would pay more taxes on the interest received if the interest payments were taxable. Additionally, the tax-free interest is why municipal bonds are not suitable for retirement accounts. This is because the earnings in retirement accounts are already tax deferred, and the impact of receiving tax-free interest is lost or diminished. LO 5.g

Which of the following is a double-barreled bond? A) New Housing Authority (NHA) bond B) Anticipation note C) General obligation bond to construct a new grade school D) Hospital bond backed by revenues and taxes

D A double-barreled bond is backed by a defined source of revenue other than property taxes, as well as the full faith and credit of an issuer with taxing authority. NHA bonds are not double-barreled. If rental income from the housing cannot meet servicing costs, the shortfall is covered by the federal government. To be double-barreled, the issue must be backed by more than one municipal source. LO 5.c

All of the following statements regarding municipal bond official statements are true except A) all retail purchasers of a new municipal bond issue must receive a final official statement. B) a retail customer must receive an official statement no later than the settlement date. C) a municipal securities broker-dealer may satisfy the delivery requirements by providing a notice advising the customer how to obtain the official statement from Electronic Municipal Market Access (EMMA). D) an official statement must be delivered only upon request of a retail customer.

D A final official statement must be delivered to retail buyers of a new issue on or before the settlement date. With today's technology, most investors receive their official statement through EMMA. LO 5.a

If an investor were to purchase a bond in the secondary market several years after the public offering, which of the following would factor in calculating the total dollar amount paid for the bond? Settlement date Dated date Coupon Scale A) I and IV B) II and IV C) II and III D) I and III

D Accrued interest is part of a bond transaction's total dollar amount. To calculate the accrued interest, you must know the settlement date. The dated date is only relevant for the first interest payment, so it would not apply to this trade. LO 5.f

The computation for accrued interest on corporate and municipal debt obligations is based on A) an actual-day month and an actual-day year. B) an actual-day month and a 360-day year. C) a 30-day month and an actual-day year. D) a 30-day month and a 360-day year.

D Accrued interest on corporate and municipal bonds is computed on a 30-day month and a 360-day year. LO 5.f

A May and November Treasury bond is traded the regular way on Wednesday, June 8. The number of days of accrued interest is A) 45. B) 38. C) 44. D) 39.

D Accrued interest on government bonds is based on actual days in a year. Settlement occurs on the next business day. This bond pays interest in May and November, with the most recent payment on May 1. Interest has accrued on this bond for 31 days in May and 8 days in June, for a total of 39 days. The settlement date is Thursday, June 9. LO 5.f

An associate of a broker-dealer engaged in municipal securities activities such as soliciting municipal bond business but is not involved in retail sales A) may sell municipal bonds to professional bond traders only. B) is required to be employed by the MSRB. C) is required to be an elected official of a municipality. D) is known as a municipal finance professional (MFP).

D An MFP is an associate of a broker-dealer engaged in municipal securities representative activities, other than retail sales. Those activities can include the solicitation of municipal bond business. Though someone employed by a broker-dealer is not prohibited from being an elected official of a municipality, there is no requirement that an MFP must be. Being employed by a broker-dealer dealing in municipal bonds and the MSRB simultaneously would be prohibited as a conflict of interest. LO 5.j

Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with A) capital losses. B) gains associated with variable annuity portfolios. C) losses on options positions. D) tax preference items.

D Certain items receive favorable tax treatment from the IRS. One example is tax-exempt interest on private-purpose municipal revenue bonds. These types of items are known as tax preference items. For investors who are subject to the AMT, the benefits normally associated with tax preference items are lost because these items must be added back into the investor's taxable income. LO 5.g

Investors who are subject to the alternative minimum tax (AMT) will lose the tax benefits normally associated with A) gains associated with variable annuity portfolios. B) capital losses. C) losses on options positions. D) tax preference items.

D Certain items receive favorable tax treatment from the IRS. One example is tax-exempt interest on private-purpose municipal revenue bonds. These types of items are known as tax preference items. For investors who are subject to the AMT, the benefits normally associated with tax preference items are lost because these items must be added back into the investor's taxable income. LO 5.g

The interest from which of the following bonds is subject to federal income tax? I. State of Nebraska II. City of Duluth III. Treasury notes IV. Federal National Mortgage Association (FNMA) A) I and III B) I and II C) II and IV D) III and IV

D Direct federal debt, such as a Treasury note, is subject to federal income tax but exempt from state tax. FNMA bonds are subject to federal, state, and local taxes. State and city bonds, being municipals, are exempt from federal income tax. LO 5.g

Which of the following statements regarding distributions from a Section 529 education savings plan is true? A) Distributions can be used for preschool education expenses only. B) Distributions can be used for college education expenses only. C) Distributions can be used for K-12 education expenses only. D) Distributions can be used for K-12 and college education expenses.

D Distributions from Section 529 plans can be used for grades K-12, as well as college education expenses. LO 5.h

A representative wishes to execute an order for a customer's discretionary account. The municipal dealer has a control relationship with the issuer of the security to be purchased. Under Municipal Securities Rulemaking Board rules, the representative A) must wait until the firm terminates the control relationship. B) may refer the customer to a firm that has no control relationship. C) may not execute the order. D) must have specific authorization from the customer.

D Even in a discretionary account, a registered representative may not exercise discretion when a control relationship exists between the issuer and the dealer without first receiving the customer's permission. LO 5.j

The ratio of taxes collected to taxes levied might be used in the analysis of which of the following bonds? A) Industrial development revenue B) Pollution control C) Water control D) General obligation

D General obligation bonds are mainly supported by taxes. Collection of these taxes is a factor in the issuer's ability to pay the debt service on the issue. LO 5.c

A customer buys a new issue municipal bond with a dated date of January 1 for settlement on January 31. If the first interest payment date is March 1, how many days of accrued interest will the customer pay to the syndicate? A) 0 B) 31 C) 60 D) 30

D In this new issue, interest begins to accrue as of the dated date, so the customer (buyer) must pay the syndicate interest from the dated date up to, but not including, the settlement date. The number of days from January 1 up to, but not including, January 31 is 30. LO 5.f

According to Municipal Securities Rulemaking Board (MSRB) rules, if a municipal securities broker-dealer receives an advisory fee from an issuer, it must notify, in writing, any of its customers purchasing bonds issued by that municipality of A) all of these. B) the placement ratio. C) a negative outlook from Standard & Poor's. D) any advisory relationship existing between itself and the issuing municipality.

D MSRB rules require that if a broker-dealer has an advisory relationship with a municipality, that relationship must be disclosed to any of the broker-dealer's clients who are buying bonds issued by the municipality. LO 5.j

You sell a municipal bond that has been advance refunded. It will be called at 102 four years from now. On the confirmation, the yield must be stated as the yield to A) maturity. B) maturity or yield to call, whichever is higher. C) maturity or yield to call, whichever is lower. D) call.

D Municipal Securities Rulemaking Board rules require that when a call date has been fixed by a pre-refunding, the yield to call so fixed must be reflected on the confirmation statement. Because of the pre-refunding, this bond issue will be called at the call date. There is no uncertainty surrounding this event. Therefore, it is appropriate to price the bond to the call date. The old maturity on the bond has no further significance. LO 5.e

A municipal bond is purchased in the secondary market at 102½. The bond has five years to maturity. Two years later, the bond is sold for 102. The tax consequence to the investor is A) a capital loss of $5 per bond. B) no capital gain or loss. C) a capital loss of $20 per bond. D) a capital gain of $5 per bond.

D Municipal bonds bought at a premium, either in the new issue or secondary market, must be amortized. The amount of the premium is 2½ points, or $25. As the bond has five years to maturity, the annual amortization amount is $5 per bond. After two years, the bond's basis has been amortized down to 101½. At that point, a sale at 102 generates a capital gain of $5 per bond. LO 5.f

A municipal finance professional (MFP) is A) employed by a municipality to oversee the issuance of municipal bonds. B) an elected official of a municipality having some decision-making authority regarding new municipal bond issues. C) an employee of the Municipal Securities Rulemaking Board (MSRB) specializing in seeing that broker-dealers adhere to the MSRB rules and regulations regarding the sales of municipal bonds to retail customers. D) an employee of a broker-dealer engaged in municipal security representative activities other than retail sales or who solicits municipal securities business for the broker-dealer.

D Per the MSRB, an MFP is an associated person of a broker-dealer who is primarily engaged in municipal securities representative activities other than retail sales to individuals, who solicits municipal securities business for the broker-dealer, or who is in the supervisory chain above MFPs. LO 5.j

Each of the following are generally used to service state general obligation bond issues except A) sales taxes. B) motor vehicle license fees. C) income taxes. D) real estate taxes.

D State-issued municipals are backed by state revenues, including sales and income taxes, as well as fees for state-issued licenses and permits. States do not normally levy property (real estate) taxes. Real estate taxes—known as ad valorem taxes—are typically levied by local municipalities such as cities and counties. LO 5.c

A local school district needs to invest funds short term. They do so in a trust formed specifically for this purpose, which allows the municipal entity to purchase shares or units of the trust's investment portfolio. This investment vehicle is known as A) a state and local government securities (SLGS). B) a unit investment trust (UIT). C) a trust anticipation note (TAN). D) a local government investment pool ( LGIP).

D States establish LGIPs to provide other government entities such as cities, counties, school districts, or other state agencies with a short-term investment vehicle to invest funds. The LGIPs are formed as trusts in which municipalities can purchase shares or units in the pools investment portfolio. LO 5.h

All of the following statements regarding a municipality's collection ratio are true except A) the collection ratio is calculated as follows: taxes collected divided by taxes assessed. B) a high collection ratio is more favorable than a low collection ratio. C) the collection ratio measures the municipality's property tax collections. D) a poor collection ratio might mean the municipality is likely to default on its revenue bonds.

D The collection ratio measures taxes collected versus taxes assessed. It is a tool used in analyzing general obligation bonds, which are backed by the taxing authority of the issuer. Revenue bonds are backed by user fees, not taxes. LO 5.c

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) I and II B) II and III C) II and IV D) I and III

D 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. LO 5.c

A customer in the 28% tax bracket wants to buy a municipal GO bond with a 7.5% yield that matures in 6 years. The tax-equivalent yield of this bond is A) 0.060. B) 0.075. C) 0.026. D) 0.104.

D To calculate the taxable return, use the tax-free equivalent yield formula: municipal bond yield ÷ (1 − investor's tax bracket). Using this formula, 0.075 ÷ (1 - 0.28) = 0.104, or 10.4%. This means the investor, who is in the 28% tax bracket, must earn 10.4% in taxable interest to equal the 7.5% tax-free municipal interest yield. LO 5.g

Which of the following details would not be found on the bond resolution for a revenue bond? A) The maintenance covenant B) The insurance covenant C) The rate covenant D) The tax covenant

D Unless something in the question refers to special taxes, revenue bonds do not have tax backing. The other items are included in the bond resolution (or trust indenture). The rate covenant is a promise to maintain rates sufficient to pay expenses and debt service. The maintenance covenant is a promise to maintain the equipment and facility/facilities. The insurance covenant is a promise to insure any facility. LO 5.c

Voter approval may be required for new bond issues for construction of which of the following? I. Airports II. Turnpikes III. State prisons IV. Public high schools A) I and III B) I and II C) II and IV D) III and IV

D Voter approval may be required for new issues of GO bonds. State prisons and public high schools are among the facilities for the public good that are built and supported by GO issues. User fees (like tolls) support revenue bond issues for the construction of facilities such as airports and turnpikes. LO 5.c

Several years ago, one of your customers bought an original issue discount (OID) municipal bond at $960. The bond has now matured. For federal income tax purposes, the discount is A) taxed at maturity as ordinary income. B) taxed as a long-term capital gain. C) taxed each year as ordinary income. D) tax free.

D When buying an OID municipal bond, the discount must be accreted each year and treated as interest income. Because interest income from a municipal bond is tax free at the federal level, the discount is not taxed if the bond is held to maturity. If the customer had purchased at a discount in the secondary market, the discount would have been accreted and taxed as ordinary income. LO 5.g

An investor purchased a municipal bond at par to yield 5.5% to maturity. Two years later, if he sells the bonds at a price equivalent to a 5% yield to maturity, the investor incurs A) tax-free income. B) a capital loss. C) no taxable result at this time. D) a capital gain.

D Yields fall as bond prices rise. Because the yield to maturity has dropped, the bond is trading at a higher price than when it was purchased. The consequence of the sale is a capital gain because the investor sold the bond that was purchased for par at a premium. LO 5.f