Part 2 Unit 6

What are the roles for municipal brokers' brokers

- they perform specialized trades for institutions - they act as agents only in trades between dealers or institutions - they do not maintain inventories (meaning they do not act as principals) - they do not perform retail trades with individual investors - they do not do retail business

When can an extraordinary call occur?

An extraordinary call can occur at an unknown point in time prior to maturity. The issuer has the right to call the bonds, generally at par, when a certain event occurs, typically a catastrophe.

A customer buys a municipal bond in the secondary market at 96 that has four years to maturity. Two years later, the customer sells the bond at 99. The tax consequences of this investment are A) three points of ordinary income. B) two points of ordinary income and one point of capital gain. C) three points of capital gain. D) two points of capital gain and one point of ordinary income.

B) two points of ordinary income and one point of capital gain. Explanation: When a municipal bond is purchased in the secondary market at a discount, the annual accretion is taxed as ordinary income. The annual accretion is one point per year (four points divided by four years to maturity). Therefore, when the bond is sold two years later, its cost basis is 98. If the bond is sold at 99, there is a long-term capital gain of one point per bond. Also, there is ordinary income taxation on the accretion of two points.

Which of the following would have the least market risk? A) Fannie Maes B) AAA corporate debentures C) Revenue anticipation notes D) Corporate or municipal bonds with long-term maturities

C) Revenue anticipation notes Explanation: Anticipation notes are the shortest term, which gives them the least market risk (the risk that price will fluctuate during the time left to maturity).

A significant portion of municipal bond trading is done by dealer banks. These are commercial banks that are not members of FINRA or any exchange. For those market participants, enforcement is in the hands of all of the following except A) The Office of the Controller of the Currency (OCC). B) The Federal Deposit Insurance Corporation (FDIC). C) The Municipal Securities Rulemaking Board (MSRB). D) The Federal Reserve Board (FRB).

C) The Municipal Securities Rulemaking Board (MSRB). Explanation: The MSRB makes rules but is not the one who enforces them. When it comes to bank dealers, those MSRB rules are enforced by these banking agencies. For securities firms, enforcement is in the hands of FINRA.

An investor in the 28% income tax bracket is considering purchasing either a 4% municipal bond or a 5% corporate bond. Which of the following statements regarding the two bonds' after-tax yields is true? A) The corporate bond's yield is higher than the municipal bond's yield. B) The two bonds' yields are equivalent. C) The municipal bond's yield is higher than the corporate bond's yield. D) The yield difference cannot be determined.

C) The municipal bond's yield is higher than the corporate bond's yield. Explanation: Investors should invest in municipal bonds if the return after taxes is higher than comparable taxable bonds. To compare the two bonds, use the tax-free equivalent yield formula: (taxable yield) × (100% - tax bracket) = (tax-free equivalent yield). In this case, 5% × (100% - 28%) = 5% × 0.72 = 3.6%. Because the municipal bond yields 4% tax free, the investor should buy it; after taxes have been paid, the corporate bond yields only 3.6%.

When an outstanding bond issue is the subject of a refunding, the holders of those bonds have their claim on any pledged assets terminated. This is known as A) termination. B) default. C) replacement. D) defeasance.

D) defeasance.

Defeasance

Defeasance occurs when an outstanding bond issue is paid off prior to maturity through a refunding. Once the creditors (the bondholders) have received their funds, any liens on assets or revenues are terminated.

A 3% bond with 20 years to maturity is being issued by a syndicate with a reoffering yield of 4%. What is the term used to describe this bond? A) Secondary market discount B) High-yield bond C) Original issue premium D) Original issue discount

Explanation: Because the bond is being issued by a syndicate, it is a new issue (i.e., an original issue). Because the yield (4%) is higher than the coupon (3%), it is an original issue discount.

If a municipal bond with 10 years to maturity is purchased from the issuer for 110, and after two years, it is sold for 110, the bondholder must report A) no capital gain or loss. B) capital gain of two points. C) capital gain of 20 points. D) capital loss of two points.

Explanation: Municipal bonds bought at a premium must be amortized. The amount of the premium is 10 points. With 10 years to maturity, the annual amortization is one point. After two years, the bond's cost basis has been amortized down to 108. If at that point it is sold for 110, there is a two-point capital gain.

What are schools funded by?

GO bonds

What does the MSRB do?

It makes rules, but does not enforce it Kind of like how congress legislation makes the rules, and executive branch enforces them

When a bond is issued by a syndicate, what does that mean?

That means it's a new issue (original issue)

What does the call premium represent?

The call premium represents the difference between the call price and par. The farther away a call date, the lower the call premium

What market is a firm's trading desk in?

The secondary market

What is basis?

Yield to Maturity (YTM)

With bonds subject to a gross revenue pledge, the first priority will be to pay

bond interest and principal

The unqualified legal opinion on a municipal bond states that _______________________.

the issuer has the authority to issue bonds that are legal, valid, and enforceable obligations of the issuer.

The maximum political contribution allowed under Municipal Securities Rulemaking Board rules for those eligible to vote in the municipality issuing debt on a negotiated basis is _______.

$250

Dealer banks are commercial banks that are not members of FINRA or any exchange. Who enforces them?

- The Office of the Controller of the Currency (OCC) - The Federal Deposit Insurance Corporation (FDCIC) - The Federal Reserve Board (FRB)

The indenture of a revenue issue would ordinarily include....

- adequate insurance on the property - proper maintenance of the property

Notes on GO (General Obligation) bonds

- backed by taxes (so rising unemployment= bad)

Disclosure to customers of control relationships is required in

- principal transactions - primary distributions - agency transactions - secondary transactions

What activities can occur in the muni bond second market?

- retail and institutional transactions - trades done by broker's broker

What must be considered by an investment adviser representative before recommending a municipal general obligation (GO) bond to a customer?

- the customer's tax status - the muni's security rating - the customer's state of residence

What would be found in a bond resolution?

- the issuer's obligation to bond holders - covenants that the issuer must adhere to (ex- covenants between the issuer and the trustee acting for the bondholder - a description of the issue - call provisions - (the cost to be incurred by the issuer in connection to the offering is NOT included)

What can the MSRB adopt rules on?

- the sale of new issues to related portfolios - the form and content on price quotations - the regulation of muni security advertising - CANNOT adopt rules on the info to be provided by muni issuers

One of your customers buys a new issue municipal revenue bond on March 19. The trade settles on March 21, and the bond pays interest on February 1 and August 1. If the dated date of the bond is March 1, how many days of accrued interest are due? A) 20 B) 55 C) 24 D) 19

A) 20 Explanation: Interest started accruing from the dated date of the bond (March 1). Interest accrues up to, but not including, settlement. Therefore, 20 days of accrued interest are due. The customer's first interest payment the following August will represent interest that has accrued from the dated date.

Which of the following would be of least concern to a registered representative recommending a municipal security to a customer? A) Availability of the security B) Customer's state of residence C) Municipal security's rating D) Customer's tax status

A) Availability of the security Explanation The customer's state of residence and tax status are essential when determining suitability of a municipal security. The security's rating is also important because it measures the bond's safety and quality and should align with the customer's risk tolerance. While the availability may pose a challenge for the broker-dealer and could potentially add to the cost of the transaction, it would be of the least concern regarding suitability unless the cost was in some way prohibitive.

The MSRB classifies municipal securities into two categories: notes and bonds. They define bonds as any municipal debt security with a maturity of A) 1 year or more. B) 3 years or more. C) 10 years or more. D) 2 years or more.

B) 3 years or more. Explanation: Municipal notes have a maximum maturity of less than three years. Once the municipal security is issued with a maturity of 3 years or longer, it is considered a municipal bond.

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) Corporate bond B) General obligation (GO) bond C) Treasury bond D) Industrial revenue bond

B) General obligation (GO) bond Explanation: 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.

A city has issued bonds to construct a new sewage treatment facility. If the bonds are not backed by the full taxing authority of the city, all of the following statements about the bond issue are true except A) the interest on these bonds is not considered a preference item for the alternative minimum tax. B) there is no debt limitation on the issue. C) the disbursement of principal and interest payments must be approved semiannually by the state public service commission. D) if earnings fall short of the amount needed to make principal and interest payments, the debt service reserve can be used.

C) the disbursement of principal and interest payments must be approved semiannually by the state public service commission. Explanation: As an exclusion question, we are looking for the false statement. The public service commission would have no approval power over revenue bond interest and principal payments. Because the bond is not backed by the taxing authority of the city, it is a revenue bond rather than a general obligation bond. The funds for payment of interest and repayment of principal are generated through the fees paid by those using the city's water and sewage facilities. Being a public, rather than private, facility, these would not be alternative minimum tax bonds.

For which of the following would the net revenue-to-debt service ratio be applicable? A) School bonds B) General obligation bonds C) Tax anticipation notes D) Hospital bonds

D) Hospital bonds Explanation: This is the coverage ratio. Because revenue bonds are only backed by funds generated by a specific source, it is important that net revenues exceed debt service requirements. Hospitals are often built with the proceeds of revenue bond issues.

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

D) II and III Explanation: 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 responsibilities did the Municipal Securities Rulemaking Board (MSRB) receive through the Securities Acts Amendments of 1975? I. Regulation of municipal issuers II. Establishment of recordkeeping requirements for municipal broker-dealers III. Enforcement of any municipal regulations it adopts IV. Creation of regulations for participants in the municipal securities secondary market A) I and IV B) II and III C) I and III D) II and IV

D) II and IV Explanation: The MSRB creates rules for municipal trading and issues interpretations of its rules. It does not regulate issuers or have any enforcement capability. For broker-dealers, MSRB rules are enforced by FINRA.

The interest from which of the following bonds might be included in the alternative minimum tax calculation? A) Special assessment bonds B) General obligation bonds C) Tax anticipation notes D) Industrial development revenue bonds

D) Industrial development revenue bonds Explanation: Industrial revenue bonds, sometimes called industrial development bonds, may be nonpublic purpose bonds, and the proceeds are used to benefit private corporations. As such, the interest income from these bonds is a tax preference item in the alternative minimum tax calculation.

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 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). C) a retail customer must receive an official statement no later than the settlement date. D) an official statement must be delivered only upon request of a retail customer.

D) an official statement must be delivered only upon request of a retail customer. Explanation: 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.

An investor buys a GO bond with a coupon of 3½% that has a basis of 3¾ %. If the bond is held until maturity, the investor's actual yield will be A) 3¾ %. B) more than 3¾ % . C) 3½ %. D) more than 3½ % but less than 3¾ %.

D) more than 3½ % but less than 3¾ %. Explanation: This is tricky, so follow along. With a coupon of 3½ % and a basis (yield to maturity) of 3¾ %, we know the bond was purchased at a discount. GO bonds are municipal bonds, and when a municipal bond is purchased in the secondary market at a discount, the accretion of the discount is taxed as ordinary income. Therefore, a portion of the investor's return will be taxable, making the actual return slightly less than the yield to maturity.

What are revenue bonds paid out of?

Revenue bonds are paid out of revenues from a particular project or facility, not from tax revenue.

Disclosure requirements for issuers are mandated by the ______.

SEC

What does the bond resolution include?

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

There are few restrictions on who may be the first beneficiary of a Section 529 plan. However, if the beneficiary is redesignated, the new beneficiary must be___________.

a close family member of the first

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

The nature of any control relationship or conflict of interest must _______________.

be disclosed to customers.

One of the benefits of adding a sinking fund provision to a municipal bond issue is that the bond will generally____________.

be issued with an interest rate lower than without the sinking fund.

It is not uncommon for municipal revenue bonds to have a catastrophe call provision. Another term that might be used for this provision is__________.

extraordinary call

A workable indication is usually a __________ from a dealer and holding a quote is one that is firm for a specified time.

firm bid price

Adding a sinking fund provision to a bond issue invariably results in a _________rating for the security

higher

a ________quote is on that is firm for a specified time

holding

What might be included on the alternative minimum tax calculation?

industrial development revenue bonds

A double-barreled bond....

is a bond that has its principal and interest baked by revenues of a facility and the general taxing authority of a municipality

Municipal bonds purchased in the secondary market are either accreted or amortized so there is _________ at maturity.

no gain or loss

A ____________quotation indicates a dealer's estimate of a security's market value. ________quotations are provided for informational purposes only and are permitted if the quotes are clearly labeled as such.

nominal, or subject; Nominal

With bonds subject to a net revenue pledge, the first priority will be to pay

operation an maintenance