Ch 7: Municipal Debt

Example of state tax effect

*Example 1*: A California resident who is in the 25% federal bracket and is subject to a 3% state income tax purchases a 4% City of Sacramento municipal bond at par. What will this investor need to earn on a fully taxable instrument to equal the tax-free yield on the municipal bond? Since the bond was purchased by a resident of California, its interest is also exempt from California state tax. Therefore, the state tax rate is factored into the equation (25% + 3%). Taxable equivalent yield = 4% / (100% - 28%) = 4% / 72% = 5.55% *Example 2*: A Wisconsin resident who is in the 25% federal bracket and is subject to a 3% state income tax purchases a 4% City of New York municipal bond at par. What will this investor need to earn on a fully taxable instrument to equal the tax-free yield on the municipal bond? Since the bond was not purchased by a resident of the state of issuance (i.e., New York), interest is subject to Wisconsin state tax. Therefore, the state tax rate is NOT included in this calculation. Taxable equivalent yield = 4% / (100% - 25%) = 4% / 75% = 5.33%

Existing holders of ARS may choose to place the following orders:

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

Types of revenue bonds (pt 1 of many)

*Housing revenue bonds*: issued by state or local housing finance agencies to fund housing for low income families. Sometimes proceeds of the bond offering are lent to the real estate developers that are constructing the property. Other times, the money raised through the offering is used to support the mortgage markets. *Dormitory bonds*: build housing for students at public universities and are repaid from a portion of student tuition payments. *Health care Revenue Bonds*: construction of non-profit hospitals and health care facilities. These bonds typically pay their debt service out of gross revenue: all revenues received will be used to pay debt service prior to deductions being taken for any costs or expenses. In some cases, the existence of nearby competing facilities will influence the quality of the bonds. *Utility revenue bonds*: issued to finance gas, water and sewer, and electric power systems that are owned by a governmental unit. Backed by user fees. Environment and the growth rate of the area being served by the utility are important when evaluating credit risk *Transportation bonds*: used to finance projects such as bridges, tunnels, toll roads, airports, and transit systems. User fees pay debt service. (Feasibility study) *Special tax bonds*: backed by special taxes (e.g., taxes on tobacco, gasoline, hotel/motel stay) for a specific project or purpose, but *not* by ad valorem taxes *Special assessment bonds*: bonds are payable only from an assessment on those who directly benefit from the facilities *Moral obligation bonds*: bonds are first secured by the revenues of a project; however, if revenues are insufficient to pay debt service requirements, the state (or a state agency) is morally obligated (but not legally required) to provide the needed funds. Prior to issuing the bonds as moral obligation bonds, the *legislative approval* of the state government must be obtained. *Education bonds*: These may be secured by the repayment of loans by students, by the money contained in a fund that was required to be established by the bond's indenture, or by insurance payments made by the state or federal government. *Lease rental bonds*: These offerings involve one municipal entity that leases a facility from another. For example, a state building authority may issue bonds to build a college dormitory and then the authority will lease the dorm to the college. The bond issued by the building authority will be paid from the revenues generated through lease payments received from the college. If the lease payment is subject to an annual budgeting process, credit risk is tied to the willingness of the issuer to budget these payments annually. *Certificates of Participation (COPs)*: type of lease financing agreement that's usually issued in the form of a tax-exempt municipal revenue bond. COPs have been used as a method of monetizing existing surplus real estate. This financing technique provides long-term funding through a lease that doesn't legally constitute a loan and, therefore, eliminates the need for a public referendum or vote.

Types of ways these OIDs are taxed

*OID Held to Maturity*: Since the accreted amount of a municipal OID is *treated as interest*, this upward adjustment in the bond's value is *tax-exempt*. Each year, the bondholder's cost basis is increased and, at maturity, the cost basis reaches par. At maturity, since the cost basis is equal to the redemption price (par), there's *no capital gain.* *OID Sold Prior to Maturity*: If an OID bond is sold prior to maturity, the *cost basis* (adjusted to reflect the accretion) is used to *calculate gains or losses*. Based on the example above, if an investor buys an OID municipal bond at a price of 60 with 10 years to maturity, the bond will accrete by 4 points each year. Therefore, after three years, the bond's basis has accreted by 12 points to a basis of 72. If the bond's adjusted basis is 72: A sale at a market price of 75 creates a 3-point capital gain (75 market price - 72 adjusted cost). A sale at a market price of 70 creates a 2-point capital loss (70 market price - 72 adjusted cost). A sale at a market price of 72 creates no capital gain or loss (72 market price - 72 adjusted cost). *Constant Yield Method*: The preceding diagram used the straight-line accretion method, which is the same process used for questions on the examination. However, the actual method of accretion used by accountants is referred to as the *constant yield method* or *constant interest method*. Students are not expected to perform this more difficult calculation. Note: If an exam question references a zero-coupon municipal bond, it should be considered an OID. Therefore, the discount is treated in the same manner as previously described.

Trust indenture covenants details

*Rate Covenant*: The issuer's pledge to maintain rates at a level that's sufficient to meet operation and maintenance costs, debt service, and certain reserve funds. *Maintenance Covenant*: The issuer's pledge to maintain the project in good working order. *Insurance Covenant*: The issuer's pledge to carry insurance on the *property*. *Financial Reports and Audits*: The issuer's pledge that it will maintain proper records and that an accounting firm will be retained to do an outside audit. This pledge is designed to avoid the possibility of funds being misused. *Issuance of Additional Bonds*: If there's a closed-end indenture, no additional bonds that have an equal claim on the pledged revenues may be issued against the same security. However, if there's an open-end indenture, additional bonds may be issued in the future for expansion of the project. Typically, before any additional bonds may be issued, the project must meet certain earnings tests. *Non-Discrimination Covenant*: This represents the issuer's pledge that no special rates will be granted to any person or group. *Catastrophe Call*: This provision provides municipalities with insurance against natural disasters. It allows for the early redemption of the bond if a catastrophic event occurs that severely damages the project which is financed by the bond offering. *Credit Enhancements*: Credit from entities other than the issuer may be obtained to provide security for the debt financing. This may come in the form of bond insurance, letter of credit, or state (or other) government guarantees.

backing of GO bonds

*State* general obligation bonds are usually secured by income tax, sales tax, gasoline tax, excise tax, and other taxes collected at the state level. For local jurisdictions, such as counties and cities, the most common source of tax revenue is from *levies on real property*. School taxes are also assessed at the local level and are normally a significant portion of a person's real estate tax assessment. *Ad valorem tax*: (property tax--usually used by local municipalities--) is determined based on the *assessed* value of property (not market value) multiplied by the tax rate levied (expressed in terms of *mills*). One mill expressed as a percentage is 0.1% or, if expressed as a decimal, it's 0.001. Ultimately, if a rate of one mill is used for tax purposes, it equates to a tax of $1 per $1,000 of assessed value. (For example, a taxpayer owns property that's assessed at a value of $300,000 and is subject to a tax of 7 mills. This means that property tax of $2,100 is owed ($300,000 x .7% or $300,000 x .007).) In addition to property taxes, sales taxes, and income taxes, other *non-tax revenue*, such as parking fees, park and recreational expenses, and licensing fees, may be used to pay the debt service on GO bonds. Certain governmental entities, such as school districts, may have an imposed *legal limit on the tax rate* at which they may assess. Bonds issued by these entities are called *limited tax general obligation bonds* since the taxing power of the issuer is limited to a specified maximum rate. *Unlimited tax general obligation bonds* are issued by government units that have no legal limitation on their taxing power. Most local general obligation bonds are unlimited tax bonds; therefore, the issuers have the ability to levy ad valorem taxes without limitation as to the rate or the amount.

Additional tax considerations

*Zero coupon municipals* Bond is issued at deep discount and accretes to mature at face value Annual accreted amount is tax-free interest *Capital appreciation Bonds (CABs)* Similar to zero coupon bonds Issued at deep discount Investment return on the initial principal value is considered to be reinvested on a compound rate at maturity At maturity the investors receive a single payment representing the initial amount and the investment return (discount is not accreted) *Private activity bonds* Typically taxable for investors who are subject to the alternative minimum tax (AMT) Yields are higher on AMT municipal bonds than non-AMT bonds (because of this disadvantage) You may lose tax-exemption status under the AMT

Net revenue pledge bonds vs gross revenue pledges

*net revenue pledge bond*: So gross revenue first pays operating and maintenance expenses, then you're left with net revenue and you pledge to use that to pay the debt service and everything else. With a *gross revenue pledge bond*, you first pay the debt service, then you use what is left to pay maintenance and operation and everything else. If the question doesn't specify, assume net revenue pledge bond

Order of flow of funds

1. *Revenue Fund*: This is the account into which all receipts and income (gross revenues) are deposited and recorded. 2. *Operating and Maintenance Fund*: This is the account into which a prorated amount of the revenue is deposited to meet the costs of operating and maintaining the project. Occasionally, there's an excess of funds which allows for the creation of a reserve fund. 3. *Debt Service (Bond Service) Fund*: This is the fund into which an amount of revenue is deposited that will be sufficient to pay semiannual interest and maturing principal. 4. *Debt Service Reserve Fund*: This is the fund into which revenue is deposited after annual debt service is ensured. These funds are only used if the debt service fund itself is insufficient to meet annual payments. 5. *Reserve Maintenance Fund*: This is the fund into which revenue is directed in order meet any unexpected maintenance expenses. 6. *Replacement and Renewal Fund*: In the event that there's a demand based on an engineer's report, this is the fund into which revenue is deposited to meet new equipment and repair costs. 7. *Sinking Fund*: This is the fund into which revenue is accumulated in order to retire bonds prior to maturity. If there's a mandatory sinking fund provision in the indenture, this fund will receive money prior to the replacement fund. An offering with a mandatory sinking fund will retire a portion of the debt prior to its stated maturity. Since the entire offering will not reach maturity, it will have an average life that's shorter than the stated maturity. 8. *Surplus Fund*: This is the fund into which excess money will be placed for use in emergencies. 9. *Construction Fund*: This is the fund into which money is allocated to use for future construction.

Ability to collect taxes (analyzing GO bonds)

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

Parity Bonds (type of revenue bond)

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

Authority to issue GO bonds

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

Other Municipal Securities (variable rate municipal securities)

ARS and VRDOs

529 Able Plans

Achieving a Better Life Experience (ABLE) plans (also referred to as 529A ABLE plans) are municipal fund securities that can be purchased to help support individuals with disabilities without jeopardizing their disability payments received from Social Security, Medicaid, or private insurance. The maximum contribution is $15,000 per year and front-loading is not permitted. The individual's other disability payments will continue if the account's value doesn't exceed $100,000. Distributions from the plans are *tax- free* if they're used to pay qualified expenses. Contributions made with *after-tax* dollars. Offering documents

Contribution limits (529 college savings plans)

Although current tax law allows a tax-free gift of up to $15,000 to any one person in any given tax year, a 529 plan may be front-loaded with an initial gift of $75,000 which is treated as if it's being made over a five-year period (five contributions of $15,000 each). Individuals may contribute these same amounts to 529 plans that are maintained for more than one beneficiary. In other words, if an individual has five grandchildren, she's able to contribute $75,000 to each grandchild's 529 plan without incurring federal gift taxes. This amount is doubled for a married couple funding multiple 529 plans. The aggregate amount able to be contributed to a 529 plan is determined by the state. Most states use a total that's sufficient to pay for an undergraduate degree.

Unfunded pension liabilities (analyzing GO Bonds)

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

Variable Rate Demand Obligations (VRDOs)

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

Net (after-tax) yield

Calculating a bond's net yield is especially important when an investor is considering the possibility of buying a taxable corporate bond and wants to know what she will be able to keep after taxes are paid. Since the interest on a corporate bond is taxable, the investor will realize a lower net (after-tax) return. To determine the net yield of a taxable investment, use the following formula: *net yield = taxable yield x (100% - tax bracket%) EX: An individual who is in the 28% tax bracket purchases a 10% corporate bond at par. What's his bond's net (after-tax) yield? Net Yield = 10% x (100% - 28%) = 10% x 72% = 7.2% For this investor, the *10% corporate bond is equivalent to a municipal bond yielding 7.2%.*

credit enhancement (analyzing revenue bonds)

Credit of an entity other than the issuer provides security of the debt financing Examples: *bond insurance*: (from municipal bond insurers who guarantee that interest and principal will be paid of issuer defaults). *letter of credit*: (guarantee from a bank that guarantees principal and interest payments) *state or other government entity* guarantees interest and principal

The debt statement (analyzing GO Bonds)

Critical tool for analyzing debt statement Various components are: ---*Direct debt:* All the debt (bonds and notes) that's been issued by the municipality ---*Net direct debt*: The direct debt (all issues) *minus* any self-supporting debt, such as revenue and note issues. In general, the net direct debt is only the general obligation debt (bonds supported by taxes). ---*Overlapping Debt*: This is the result of multiple authorities in a given geographic area having the ability to tax the same residents (examples below). ---*Total bonded debt*: The sum of *both* the long- and short-term debt of a municipality, *plus* its applicable share of overlapping debt. Example 1) Broward County, Florida issues a general obligation bond that's secured by the assessed value (property tax) within Broward County. Since the city of Fort Lauderdale lies within Broward County, part of the assessed value that secures the county debt lies in Fort Lauderdale. Due to the fact that the county's debt overlaps Fort Lauderdale, Fort Lauderdale is ultimately responsible for a portion of the county's debt. Example 2) The debt of a school district is comprised of one or more cities or towns. If a city and school district lie within the same boundaries, they're said to be coterminous and, when examining the debt of the city, the school district's debt must be shown as overlapping debt.

Treasury arbitrage restrictions

Due to the tax exempt status of municipal bond interest, municipalities are normally able to issue bonds with coupon rates that are below those of Treasury securities. This could present an arbitrage opportunity since a municipality could borrow money at a low rate of interest and invest the funds in higher yielding, risk-free Treasury securities. Treasury Arbitrage Restrictions were enacted to prohibit state and local governments from refinancing their debt and placing the proceeds into an escrow fund that invests in Treasuries with yields above a certain rate.

The auction process for ARS

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

revenue bonds--legal opinion

Every municipal issue must be issued with a legal opinion. The legal opinion is written by a recognized bond counsel that's hired by the issuer to attest to the *validity and tax exempt status* of the bond issue. Essentially, the legal opinion assures investors that the issuer has the legal right to issue the bonds. (legal opinion does NOT judge the credit rating of the municipality-- that's the job of the rating entity) If there are no existing situations that could adversely affect the legality of an issue, the bond counsel renders an *unqualified legal opinion* (this one is preferable). *qualified legal opinions* have some like limitations and qualified statements. Potential adverse situations include an issuer of a revenue bond not having a clear title to a property or an issuer that's violating local, state, or federal statutes when developing a project. Delivery of certificates without legal opinions or other documents that are legally required to accompany the certificates will *not* constitute good delivery unless they're identified as *ex-legal* at the time of the trade.

Nature of issuer's debt (analyzing GO bonds)

Examining the *fiscal responsibility* of the issuer's past attitudes toward debt is often an indicator of the issuer's present, and possibly future, ability to engage in fiscally *sound* behavior. Some important considerations include whether the issuer has maintained a *balanced budget over the last five years* and how well the issuer has maintained *fund reserves.* Any analysis must also review a municipality's *debt trend*. If a community has used debt to support the growth of its suburbs (such as building roads and schools that are needed to *support that growth)*, the debt is not necessarily bad. Conversely, if debt has been issued to finance budget deficits or to increase spending in a weak local economy, this may be an indication of an unwise fiscal policy. *Repayment schedule: serial versus term* Another factor in the analysis of the debt is the *schedule of debt repayment.* A serial bond issue (one with maturities that are staggered) provides greater flexibility when meeting debt requirements than a term issue (one with a single maturity date). This flexibility is due to the fact that serial maturities may be organized to coincide with expected tax revenues. *Future financing* also plays a part in general obligation bond analysis. Issuers that borrow early to finance school improvements or new water systems for expected future increases may ultimately be better off than a municipality that waits until it's too late to support an overburdened infrastructure.

Fiscal condition (analyzing GO bonds)

How well *public officials manage* in times of economic and financial stress is particularly important to the *credit quality* of an issuer. A *sound financial condition* indicates that the governmental entity is able to meet all of its obligations to creditors, employees, taxpayers, suppliers, and others, on a timely basis. Measuring the *financial resources* that are required to make payments will determine the issuer's financial condition.

Private activity or Alternative Minimum Tax (AMT) Bonds (type of revenue bond)

If 10% or more of the bond proceeds will be used to finance a project for a private entity (e.g., a corporation or professional sports team) and if 10% or more of the bond proceeds will be secured by property used in the private entity's business, the bonds are referred to as private activity bonds. The interest earned on a private activity bond may be subject to the AMT and the *bond's interest may be taxed at the federal level*. Due to the potential tax implication, these bonds may trade with a higher yield than issues that are not subject to this rule. *Alternative minimum tax*: The alternative minimum tax is a method of calculating a return to ensure that wealthy taxpayers pay at least a minimum amount of tax. When calculating the AMT, various adjustments are made. Some income is added which may not have been subject to regular tax, while some deductions are adjusted downward or eliminated entirely. One of the factors that may trigger an AMT liability is the receipt of interest on private activity municipal bonds, where the proceeds of municipal offerings go to benefit or finance a facility for use by a private business. Since the purchase of a private activity bond could lead to potential AMT liability, the MSRB requires an RR to disclose the bond's details on a confirmation. For any client who is subject to the AMT, an RR must ensure that any recommendations being made are suitable. For example, a client who is in the 35% tax bracket and subject to the AMT is able to purchase an AMT municipal bond yielding 4.70% or a non-AMT municipal bond yielding 4.35%. Which bond will offer the highest after-tax yield? For the AMT bond, the after-tax yield is calculated as follows: 4.70% x (1.00 - 35%) = 3.05%. For the non-AMT bond, the after-tax yield is 4.35% (and higher than the AMT bond).

Premium bonds

If a bond is purchased at a premium (above par), the premium amount must be *amortized* each year. Essentially, amortization is the process used to reduce the bond's premium over the remainder of its life. *premium bond held to maturity*: The amortized amount is subtracted from the bondholder's cost basis each year. For a municipal bond, the *amortization is not deductible for tax purposes*. If the bond is held to maturity, the cost basis will have been reduced to the redemption price of par and there will be *no loss* for tax purposes. *Premium Bond Sold Prior to Maturity:* Each year a premium bond's cost basis will be adjusted down to reflect amortization. If the bond is sold prior to maturity, the adjusted cost basis (original cost minus amortization) will be used to calculate a gain or a loss.

Other considerations (analyzing GO bonds)

If a community is involved in a *lawsuit*, any *liability* that a municipality is obligated to pay will place a financial burden on the community. Such *litigation* will generally have a negative effect on the community's ability to pay the debt service on outstanding bonds. Conversely, the receipt of non-tax revenues, such as federal payments for education, may serve to *enhance* the community's ability to pay the required debt service. Tracking trends in *real estate valuation* provides a good indication of a community's health. *Analysts often concentrate more on the market value of real estate as opposed to the assessed value*. Estimating the revenues available to a general obligation bond includes the community's full evaluation, the percentage of assessed value that's taxable, and the *tax (millage) rate.* For example, a community that has a full valuation of $250,000,000, a 40% basis of assessment, and a millage rate of 20 will produce $2,000,000 in property tax (as calculated below): $250,000,000 (full valuation) x 40% (basis of assessment) = $100,000,000 $100,000,000 x .02 = $2,000,000 *(Remember, 1 mill = .001 or 0.1%.)*

Secondary market discount (SMD)

If a municipal bond is purchased at a discount in the secondary market (a discount caused by market conditions) and held to maturity, there will be a *taxable gain at maturity*. The gain is reported as *ordinary income.* *SMD Held to Maturity*: In the case of an SMD bond, the accreted amount is treated as ordinary income and is taxable. Each year the bondholder's cost basis is increased; however, this increase is viewed as ordinary income and is taxable. At maturity, the $80 difference between the purchase price and par value is reported as ordinary income and is subject to federal taxation. *SMD Sold Prior to Maturity*: As was the case with an OID, if a secondary market discount bond is sold prior to maturity, the *adjusted cost basis* (which reflects the accretion) is used to calculate gains or losses. Let's assume the client sold the SMD bond in year 4. Although the bond's original cost was 92, its adjusted cost basis is now 96. This adjusted basis is based on the fact that the bond's basis has been accreted by 1 point each year over the four years. If the bond's adjusted basis is 96 and it's subsequently sold, this will result in two events: If it's sold at a market price of 99, the two results are 1) $40 of ordinary taxable income, and 2) a 3- point capital gain (99 market price - 96 adjusted basis). If it's sold at a market price of 90, the two results are 1) $40 of ordinary taxable income, and 2) a 6- point capital loss (90 market price - 96 adjusted basis). If it's sold at a market price of 96, the two results are 1) $40 of ordinary taxable income, and 2) no capital gain or loss (96 market price - 96 adjusted basis). *similar to an OID, it's the adjusted (accreted) basis, NOT the original purchase price, that's used to calculate the capital gain or loss on any subsequent sale.*

Taxable Municipal Bonds (type of revenue bond)

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

Ratings for municipal notes

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

Municipal Fund Securities

More similar to variable contracts than other municipal debt securities Provide investment returns and have value based on the performance of an underlying pool of assets (instead of providing interest payments like other municipal securities) Don't have state par values or maturity dates and canNOT be priced based on yield or dollar price Types: LGIPs, 529 College savings plan, 529 able plans

municipal bonds

Municipal bonds are issued by states, territories, and possessions of the United States, as well as other political subdivisions (e.g., counties, cities, or school districts) and public agencies (e.g., authorities and commissions). Default risk since municipal bonds are not backed by the U.S. Treasury. Exempt from SEC and state and federal registration requirements (not exempt from antifraud provisions) Interest typically exempt from federal tax (interest also often exempt from state tax if issued to residents). Investors tend to buy in-state bonds to avoid potential federal, state, and (in some cases) local taxes.

Quotations

Municipal bonds are typically quoted (bid or offered) on a yield basis. However, some term issues are referred to as *dollar bonds* since they're quoted at a dollar price (percentage of par), rather than on a yield- to-maturity basis. Ex: 100M New York State 4.00 7-1-40 @ 6.25 - 1/2 C30 @ 100 The offering is for $100,000 face value of 4.00% New York State general obligation bonds which mature July 1, 2040 and are callable beginning July 1, 2030 at 100. The bonds are assumed to be GOs since no description beyond the name is indicated. For revenue bonds, the *project's designation is made.*

how municipal serial bonds vs term bonds are quoted

Municipal serial bonds are quoted on a yield-to-maturity basis. Municipal term bonds are quoted on the basis of a dollar price.

Debt service coverage (analyzing revenue bonds)

Nearly all revenue issues pledge a project's *net revenue* to pay the bondholders their debt service. A *net revenue pledge* indicates that operating and maintenance expenses are *deducted* from the gross project revenues *before* the revenues are applied to debt service. On the other hand, a *gross revenue pledge* indicates that debt service is paid *prior* to operating and maintenance expenses being deducted. When analyzing a revenue issue, one of the most important factors is the *debt service coverage ratio*. This ratio measures the *amount of available revenue compared to the amount of revenue needed to satisfy the debt service requirement.* (debt service coverage ratio is then found by dividing the net revenue by the debt service)

Multiple markets in the same security

Occasionally, firms participate together in joint accounts for the purpose of selling municipal securities in an arrangement that's referred to as a *secondary market trading account*. This form of a joint account is allowed to have *only one price* at which it's offering a specific security at a particular time. Participants in joint accounts are prohibited from distributing or publishing different quotations for the same security. As with a new issue, there may be an *order period* and a *takedown (member's discount).*

Out firm and recall

Out firm is a quotation that a dealer is committed to honor, usually for a set period. The firm providing the quote may also establish a specific recall period. For example, Dealer A offers bonds to Dealer B on a firm basis for one hour, with a five-minute recall. In this case, Dealer A cannot offer the bonds to any entity but Dealer B without giving Dealer B the first opportunity to take the bonds. Since the recall period is five minutes, if Dealer A recalls Dealer B, Dealer B is given five minutes to take the bonds, otherwise Dealer A is free to sell the bonds to another party. The following order qualifiers may be used by investors when they seek to sell municipal bonds: --*All or none (AON)* is a type of order which indicates that the prospective purchaser must buy all of the securities being offered if it wants to buy. --*Fill or kill* indicates that the prospective purchaser must act immediately and purchase the securities at the offering price or the quotation will be withdrawn.

who benefits the most from buying municipal bonds?

People in high tax brackets. Investors in higher tax brackets benefit more from the tax-exempt nature of municipal debt; however, municipals are generally unsuitable for investors who are in lower tax brackets or as an investment in retirement accounts (they're just taking a lower yield and they're not benefiting from the tax exemptions as much.) Even if you're in a high tax bracket, municipal bonds are not suitable to have in retirement accounts- they grow tax deferred and then when the money is withdrawn the growth is taxed as ordinary income anyway so you're taking a lower yield but not taking advantage of the tax exemptions.

Tax Considerations for municipal securities

RRs need to consider tax implications when recommending municipal bonds Taxation of interest and the capital events that are associated with these instruments.

Bond taxation

Remember, interest earned on *corporate securities* is subject to federal, state, and local taxes (*fully taxed*). On the other hand, interest earned on *U.S. government obligations* is subject to *federal tax*, but is *exempt* from state and local taxes. Municipal bonds are generally considered tax exempt. The interest is always exempt from federal taxes but not always subject to state taxes (if you buy a municipal bond issued by your home state)

Original issue discount bonds

Some bonds that are initially issued at a *deep discount* are classified by the IRS as *original issue discount (OID) securities*. The appreciation in the value of an OID (the amount of the discount) is treated differently for tax purposes than a municipal bond that's purchased in the secondary market at a discount. *The discount on an OID must be accreted.* Therefore, *each year a portion of the discount is treated as interest for tax purposes and is added to the bondholder's cost basis.* For example, if an OID bond is purchased at 60 and it has 10 years to maturity, the bond's cost basis is accreted by 4 points each year. To determine the accretion amount, the 40 point difference between the purchase price and par is divided by the 10 years remaining until maturity. Since this annual accretion is not taxable, these issues are suitable for customers who don't wish to incur a tax liability.

Tax swaps

Some investors who hold municipal bonds that have declined in value may wish to sell them to *realize the loss*. However, if they're concerned about changing the overall nature of their portfolio, a *tax swap* may be appropriate. A tax swap is executed by selling a bond at a loss and, either before or shortly after the sale, repurchasing a similar bond. In order to avoid the wash sale rule, the investor must be sure to repurchase bonds that have *material differences* from the bonds that were originally sold at a loss. Relevant factors to consider include the bond's issuer, or the coupon rate, or the maturity date. However, if a bond is purchased and subsequently sold with only different accrued interest amounts, this would be considered substantially the same. Swapping may also be done for non-tax reasons, such as to change a portfolio's maturity or to enhance its quality or yield.

Expanded use of 529 plans

Tax law has expanded the use of 529 plans. Although originally intended to accumulate funds to only pay for college educational expenses, the funds in these plans may now also be used for expenses related to elementary and secondary schools at public, private, or religious institutions. Individuals can take annual distributions of up to $10,000 from their 529 plans to pay for private school tuition and books for grades K through 12—in addition to using their account proceeds for college costs. Additionally, individuals are now permitted to withdraw up to $10,000 (lifetime limit) on a tax-free basis (a qualified withdrawal) to repay qualified student loans as well as expenses for certain apprenticeship programs. The assets in plans may be transferred to another family member (a change in beneficiary) if the original beneficiary doesn't need or use the funds for qualifying education expenses.

Fiscal responsibility (analyzing GO bonds)

The *soundness of the budget process is critical* because it shows how well a particular governmental entity is managing its fiscal affairs. Fiscal responsibility may be shown in a variety of ways such as *balancing the budget, creating rainy-day funds* for use in business cycle downturns when fewer tax receipts are collected, having a *string of budget surpluses over five years*, and *reducing expenditures* by monitoring the conditions on which services are provided.

Flow of funds (analysis of revenue bond)

The flow of funds establishes the *order and priority* of handling, depositing, and disbursing pledged revenues, as set forth in the bond contract. Generally, when received, pledged revenues are deposited into a general collection account or revenue fund that's established under the bond contract for subsequent disbursement into the other accounts that are established under the bond resolution. These other accounts provide for payment of the costs of debt service, debt service reserve deposits, operation and maintenance costs, renewal and replacement, and other required amounts. Revenues that are generated by the project fill each of the funds to a prescribed level and then *flow* to the next fund. The flow of funds described in the next card is typical of most revenue bonds. The *order of the first three funds is very important*. As described earlier, if net revenues (gross revenues minus operating and maintenance expenses) are pledged to pay debt service, the bond is referred to as a net revenue issue. On the other hand, if gross revenues are pledged to pay debt service (debt service is paid before the operation and maintenance expenses), it's known as a gross revenue issue. (For exam purposes, a *net revenue pledge is the assumed flow of funds method.*) After the first three funds, the order may vary

Demographics (analyzing GO bonds)

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

Feasibility study (analyzing revenue bonds)

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

Double-Barrelled Bonds: (type of revenue bond)

These are backed by a specific revenue source (other than property taxes) *as well as* the full faith and credit of an issuer with taxing authority (a GO issuer). Essentially, a *combination of tax dollars and revenue* dollars from the project being constructed will be used to pay the debt service on the bonds. Different from moral obligation bonds because they are legally obligated to help if revenues are short.

Industrial Development Bonds (IDBs) (type of revenue bond)

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

Advance-Refunded Bonds (type of revenue bond)

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

Measuring debt (analyzing GO bonds)

To assist analysts in comparing the debt of different communities, the *ratio of debt to a number of different factors* may be used. Typically, the analyst will use the *ratio of net direct debt plus overlapping debt (net overall debt) to assessed value or to population (debt per capita).* An analyst might also use the ratio of *annual debt service to tax and other income* to assess the quality of a GO issue. In this case, a *high ratio is indicative of a decreasing margin of safety* in the issuer's ability to repay principal and interest. If the debt service increases and tax and other income remains stagnant or decreases, there are less funds available to pay the debt service.

Bank-Qualified (BQ) Issues

To encourage banks to invest in municipal securities, some issues are specified as being bank-qualified. Banks that invest in these bonds are permitted to *deduct 80% of the interest cost* being paid to depositors on the funds that are used to purchase the bonds. In addition, the *interest income* on the bonds is *tax-free*. One *limitation* is that bank-qualified issues may *not* be private activity bonds. Issuers may designate bonds as being bank-qualified if they reasonably anticipate that the amount of such obligations will not exceed $10,000,000 in a calendar year.

Rollovers (529 college savings plans)

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

Disclosure requirement (529 college savings plan)

When promoting 529 plans, an RR is required to: Disclose the risks and costs (both fees and maximum sales charges) involved with the different types of plans Provide a disclaimer stating that, prior to investing in a plan, customers should read the official statement (disclosure document) Recommend that clients check with their home state to discover if it offers tax benefits for investing in its plan. (There's no requirement to provide the name and contact information of the Municipal Securities Principal who will approve customers' investments in the plan.)

Analyzing general obligation bonds

carry a level of default risk. When evaluating the risk of default for a general obligation bond, analysts will consider the following factors: --The overall economic health of the community including changes in property values, its largest employers, average income, and demographic factors --The tax burden and source of payments --The budgetary structure and financial condition of the issuer --The issuer's existing debt using measures such as debt per capita and overlapping debt *4 main factors of GO analysis: demographics, nature of issuer's debt, aspects affecting the issuer's ability to pay, municipal debt ratios*

type of municipal bonds

classified into two major categories—*general obligation bonds (GOs)* and *revenue bonds*. GO bonds may be issued to meet any and all needs of the issuer. In a sense, GO bonds are issued for general purposes. Unlike a revenue issue, the source of the funds that the GO issuer uses to back the bonds may come from various sources. Conversely, revenue bonds are typically issued to fund a specific project or facility, such as a bridge or road. For revenue bonds, the cash flows generated by the specific project (e.g., tolls, usage fees) are used to repay bondholders.

Municipal bonds -- the target market

corporate bonds and Treasury securities usually have a *higher coupon* than municipal bonds of similar maturity. An investor must have a way of comparing the taxation differences between these security types. The main reason that this is important is the fact that investors are most concerned with determining how much money they will be able to *keep* after paying all of the taxes that are due. *The benefit of investing in tax-exempt securities increases along with an investor's tax bracket.* A high tax-bracket investor usually pays a greater percentage of his earnings in taxes; therefore, the higher the investor's marginal rate, the *greater the benefit of receiving a tax-free coupon.* Conversely, *municipals are unsuitable for investors who receive special tax considerations*. For example, since the earnings in a pension fund accrue on a tax-deferred basis, the fund doesn't derive any additional benefit from investing in tax-exempt municipal bonds. Municipal bonds are also generally unsuitable investments for an individual's IRA and 401(k) accounts.

Taxable equivalent yield

examine the issue from the other point of view. If a customer is considering the possibility of purchasing a tax-free bond and wants to calculate what he needs to earn on a taxable issue to achieve an equivalent return, the taxable equivalent yield calculation is used. To determine the taxable equivalent yield of a tax-exempt investment, the formula is: *Taxable equivalent yield = Municipal yield/ (100% - Tax Bracket)* May be adjustable-- with state tax effect EX: An individual who is in the 25% bracket purchases a 6% municipal bond at par. What will the individual need to earn on a fully taxable instrument (e.g., a corporate bond) to equal the tax-free yield on the municipal bond? Taxable equivalent yield = 6% / (100% - 25%) = 6%/75%= 8% In other words, if a client buys the 8% taxable bond, but is required to pay 25% of his earnings in taxes, he will be left with a net (after-tax) return of 6%. For this investor, an 8% taxable issue and the 6% tax-free issue are equivalent. EX: An individual who is in the 35% tax bracket purchases the same 6% municipal bond at par. What's the bond's taxable equivalent yield? Taxable equivalent yield = 6% / (100%-35%) = 6% / 65% = 9.23% This example shows that the same 6% bond is more attractive to an individual who is in a higher tax bracket. This 35% tax-bracket investor will need to find a taxable bond that yields 9.23% to be equivalent to the 6.00% tax-free issue.

Triple-tax-exempt issues

interest earned on bonds that are issued by a territory or possession of the U.S., such as Puerto Rico, the U.S. Virgin Islands, Guam, and American Samoa, are not subject to federal, state, or local taxes. These securities are referred to as triple-tax-exempt bonds.

Local Government Investment Pools (LGIPS)

investment pools created by state and local governments to provide municipal entities a safe and liquid place to invest funds. Although municipalities are generally prohibited from investing in money market funds, these pools are structured in a manner that's similar to money market funds. The pools provide both liquidity and minimal price volatility, but are not open to the public.

Analyzing revenue bonds

investors are repaid from the cash flows generated by the project that was constructed. Therefore, for revenue bond analysis, a key factor is the *comparison of the money being collected from users of a facility to the amount of debt service that must be paid to the bondholders.*

Revenue Bonds

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

The state tax effect

it may be necessary to adjust the taxable equivalent yield calculation if a question provides information about a customer's *state income tax rate*. The key to solving these more complicated taxable equivalent yield calculations is to *adjust the divisor* in the formula to account for any *additional potential tax exemption*. Since investors who purchase in-state municipal issues are exempt from both federal and state taxes, this *combined tax liability* is subtracted from 100% to calculate the divisor. Investors who purchase out-of-state municipal issues are still subject to state tax; therefore, only the federal liability is subtracted from 100% to calculate the divisor. Essentially, the divisor in the taxable equivalent yield calculation is *100% minus any tax liability* from which the bond's interest is *exempt* for a given investor.

honestly just read the google doc these are a shit show

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Auction Rate Securities (ARS)

long-term investments with a short-term twist—the interest rates or dividends they pay are reset at frequent intervals through auctions. Investors who purchase ARSs are typically seeking a cash-like investment that pays a higher yield than available from money-market mutual funds or certificates of deposit. Generally, there are two types of ARSs: *bonds* with *long-term maturities* (20 to 30 years) issued by corporations, municipalities, student loan authorities, and museums, and *preferred shares* with a cash dividend issued by closed-end funds. Both the interest rate on the bonds and the dividend on the preferred shares will vary based on rates that are set through auctions for a specified short period that's usually measured in days—7, 14, 28, or 35. This is unlike a traditional bond that's issued with an interest rate that's set for its life or preferred stock that specifies the dividend rate for its life. The *interest rate/dividend rate is determined* through a *Dutch auction process*. Before each auction, current ARS investors may request to hold their existing position at the new interest/dividend rate that's established by the auction, hold their existing position at a specified interest/dividend rate, or sell their ARSs. The size of any given auction will depend on how many current ARS investors want to sell and how many want to hold at a certain minimum rate. Essentially, the auction procedures that are set forth in most *offering documents* allow for a variety of different types of auction orders to be placed with an auction dealer.

Preference for local issues

primary benefit of purchasing a municipal security is the fact that the interest is either fully or partially tax-free to the investor. If an investor buys an in-state municipal bond, the interest earned is exempt from federal, state, and local income taxes. However, if an investor buys an *out-of-state* municipal security, the interest earned is still exempt from federal tax, but usually subject to state and local taxes.

Section 529 college savings plans

savings vehicles created to meet the expenses of higher education. contributions are made with after-tax dollars, but any earnings grow on a tax-deferred basis. If withdrawals are used to pay for higher education, they're considered *qualified* withdrawals and are *tax-free*. States that offer 529 plans are responsible for determining the specific plan rules such as allowable contributions, investment options (e.g., mutual funds), and the deductibility of contributions for state tax purposes.

GO bonds (general obligation bond)

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

Escrowed-to-Maturity (ETM) Bonds (type of revenue bond)

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

municipal notes

short-term issues (generally a year or less) normally issued to assist in financing a project or to help a municipality manage its cash flow. interest-bearing securities that ultimately pay interest at maturity. Types: *TANs*: Tax anticipation notes. issued to finance current municipal operations in anticipation of future tax receipts from property taxes. They're usually general obligation securities. *RANs*: Revenue anticipation notes. issued for the same purpose as TANs except that the anticipated revenues are typically federal or state subsidies. Like TANs, they're usually general obligation securities. *TRANS*: Tax and Revenue Anticipation Notes. These are created when TANs and RANs are issued together. *BANs*: Bond Anticipation Notes. Issued to obtain financing for projects that will eventually be financed through the sale of long-term bonds. *GANs*: Grant anticipation notes. Issued in expectation of receiving funds (grants) from the federal government. *CLNs*: Construction Loan Notes. Issued by municipalities to provide funds for construction of a project that will eventually be funded by a bond issue.

Build America Bonds (BABs) (type of revenue bond)

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

Capital gains and losses on municipal issues

understand the differences between the taxation of *interest* on municipal bonds and the potential *capital events* associated with these securities. Securities such as stocks, bonds, and options are considered capital assets and, if a capital asset is *sold* for less than its cost, the result is considered a capital loss. On the other hand, if a capital asset is sold for more than its cost, it's considered a capital gain Although the *interest* on municipal bonds is *exempt* from federal taxation, any resulting *capital gain* from the *sale or redemption* of a municipal bond IS *subject to tax*. In some cases, the gain is reported as *ordinary income.* Municipal bonds are identified based on the circumstances surrounding their purchase. The following are the three different classifications of municipal issues: 1. *Ordinary issue discount bonds* 2. *Secondary market discount bonds* 3. *Premium bonds*

Trust indenture covenants (analyzing revenue bonds)

various provisions that are found in the bond's *indenture* that should be examined when analyzing revenue bonds. The indenture is also referred to as the *bond resolution or trust agreement.* The indenture is a contract between the issuer and the trustee that has been appointed to represent the bondholders' interests. The indenture includes a variety of provisions that establish the issuer's responsibilities and the bondholders' rights. Since the indenture describes the legal protections that are afforded to bondholders, it's essential to analyze some of the various *covenants (promises)*. The typical covenants include: *rate covenant, maintenance covenant, insurance covenant, financial reports and audits, issuance of additional bonds, non-discrimination covenant, catastrophe call, credit enhancements.*