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Debt Chapter 2 - Municipal Debt - Series 7
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- Debt Chapter 2 - Municipal Debt - Series 7
Cayla J.
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A municipality wishes to sell a bond issue that is NOT backed by taxing power. Which of the following bonds could be issued?
I Revenue bond
II Industrial revenue bond
III General obligation bond
IV Lease rental bond
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
General obligation bonds are backed by a taxing power pledge. Revenue bonds do not have such backing - instead only the pledge of revenues from some enterprise activity backs the issue. Industrial revenue bonds are a type of revenue bond where a corporation's lease payments are the pledged source of revenue; a lease rental bond is another type of revenue bond where rent payments from a lessee of real property are the source of pledged revenue.
Periodic deposits of monies to the sinking fund are required to cover required:
A. interest payments only
B. principal payments only
C. interest and principal payments
D. interest payments and principal payments; and optional principal payments
The best answer is C.
Debt service is defined as payment of interest and principal as due. There is no requirement to fund optional deposits to a sinking fund. An issuer might make additional optional payments into the sinking fund to retire bonds by open market purchase, tender or call, if such would be advantageous to the issuer.
As stated in the flow of funds found in a revenue bond issue's trust indenture, monies to meet debt service requirements are deposited to the:
A. Revenue Fund
B. Debt Service Reserve Fund
C. Sinking Fund
D. Surplus Fund
The best answer is C.
Monies to meet debt service requirements are deposited to the sinking fund. The bondholders are paid their annual debt service requirements from this fund. The Debt Service Reserve fund is used for "extra" deposits above and beyond the annual requirement.
Level debt service is best described as:
A. debt service remains the same amount each year
B. debt service decreases as the years progress
C. principal repayments decrease as the years progress
D. principal repayments stay the same as the years progress
The best answer is A.
Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.
A promise by a municipality to call in a bond issue if the facility built with the proceeds of the offering is condemned, is a:
A. calamity call covenant
B. rate covenant
C. maintenance covenant
D. insurance covenant
The best answer is A.
A calamity call covenant is a type of optional mandatory call provision that obligates an issuer to call in the bonds if the facility is destroyed by some catastrophic event. Since the facility would be insured, the insurance monies are used pay for the retirement of the bonds.
Income sources backing a special tax bond issue could be all of the following EXCEPT a(n):
A. gasoline tax
B. property tax
C. sales tax
D. alcohol tax
The best answer is B.
Ad valorem (property) taxes do not back special tax bond issues. Ad valorem taxes back general obligation bonds. The definition of a special tax bond is one which is not backed by ad valorem taxes, but rather by another tax source (such as excise, sales and income taxes).
All of the following statements are true regarding Construction Loan Notes ("CLNs") EXCEPT:
A. When the facility is completed, the permanent financing is added to the outstanding balance ("basis") of the CLNs
B. Accrued interest on CLNs is computed on an actual day month / actual day year basis
C. The maturity of CLNs is generally 2 to 3 years
D. The use of CLNs allows the municipal issuer to reduce its interest cost when constructing a new facility
The best answer is A.
Construction Loan Notes (CLNs) are a type of short term municipal note used to finance the construction of buildings. Municipalities use CLNs because lenders are reluctant to finance a building until it is completed (for example, a bank will not give a mortgage on a house until there is a certificate of occupancy issued). Thus, during the construction period (which can take a number of years), short term financing is used. Once the building is completed, a long term bond issue is floated, and the proceeds are used to pay off the notes. (This long term financing is often called a "take out" loan, since it takes out the original short term financing).
CLNs allow an issuer to reduce its interest cost, since the interest rate that must be paid on short term notes is lower than that for long term bond issues. CLNs typically have a maturity of 2 to 3 years, to coincide with the projected construction period of the building.
Accrued interest on all municipal short term notes is computed in a manner similar to other money market instruments - an actual day month / actual day year basis. Please note that this is not true for long term municipal bonds, which accrue interest on a 30 day month / 360 day year.
The first statement is false. When the long term financing is completed, the proceeds are used to retire the CLNs. The proceeds of the long term bond issue are not added to the original debt outstanding.
A municipal variable rate demand note is a municipal:
A. note that may be retired prior to maturity on any interest payment date at the demand of the issuer
B. bond that gives the holder a tender option feature, usually at par, as of the reset date
C. note that requires the issuer to reset the interest rate to the market rate upon demand of the holder
D. bond that allows the issuer to vary the repayment date, upon giving written notice to the holders
The best answer is B.
A municipal variable rate demand note is a municipal bond that gives the holder the right to "put" the bond to the issuer at par, typically at the interest payment dates. The interest rate is reset, usually weekly, to an indexed rate, and thus, will vary. It is called a "note" because the actual maturity is unknown - the holder, in effect, can redeem at par whenever he or she wants. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.
The principal advantage of purchasing a variable rate municipal note is:
A. The interest rate can be expected to remain fairly stable
B. The market value can be expected to remain fairly stable
C. The marketability risk can be expected to be lower
D. The credit risk can be expected to be lower
The best answer is B.
With a fixed rate note, as interest rates rise or fall, the note's value must decrease or increase proportionately, so that the note gives a yield that approximates the current level of interest rates. Variable rate notes periodically adjust the rate of interest paid to holders, usually based upon an index of government securities. The interest rate on the notes will fluctuate up or down, depending upon market interest rates. Thus, the note always gives a yield that approximates current interest rate levels so the market price of these securities will remain fairly constant.
These notes avoid "interest rate risk," also known as market risk, since a rise in interest rates will not devalue these securities. However, they still may have marketability risk (the risk that the securities cannot be easily sold); and can have credit risk.
Variable rate municipal notes are NOT subject to which of the following risks?
A. legislative risk
B. default risk
C. marketability risk
D. interest rate risk
The best answer is D.
Variable rate municipal notes avoid market risk, also known as "interest rate risk." A rise in interest rates will not devalue these securities, since they can be put to the issuer at par at each weekly reset date. Thus, the price will not fall below par if interest rates rise. These notes are subject to legislative risk; marketability risk (Can they be liquidated quickly?); and default risk.
In a municipal bond contract, a "covenant of defeasance" would be invoked if:
I interest rates have risen subsequent to bond issuance
II interest rates have dropped subsequent to bond issuance
III call premiums on the issue are low
IV call premiums on the issue are high
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
A municipal "covenant of defeasance" allows the issuer to "advance refund" the bond issue under the terms specified in the bond contract. An issuer will take advantage of this covenant if interest rates have dropped and the issue is not currently callable. If the issue was callable, instead of advance refunding the issue, the issuer would just call in the bonds and issue new ones at the lower current interest rate. An issuer will be more likely to call bonds with low call premiums (lower cost to the issuer to call in the issue) than those with high call premiums (higher cost to the issuer to call in the issue).
The ratio of net direct debt plus overlapping debt to assessed valuation is used for all of the following EXCEPT to:
A. evaluate the issuer's ability to collect taxes owed
B. evaluate the issuer's overall ability to service its debt burden
C. analyze general obligation bonds
D. evaluate the issuer's creditworthiness
The best answer is A.
The ratio of net direct debt plus overlapping debt to assessed valuation is used to evaluate general obligation bonds (which are typically paid by ad valorem taxes collected based upon property assessments). The lower the ratio, the better the creditworthiness of the issuer and the better able the issuer is to handle servicing the debt. However, the ratio does not indicate how good a job the municipality does collecting the taxes due. This is measured by the collection ratio - the ratio of taxes collected to taxes assessed.
The flow of funds for a municipal revenue bond offering is set forth in the:
A. Official Notice of Sale
B. Trust Indenture
C. Official Statement
D. Legal Opinion
The best answer is B.
The trust indenture for a revenue bond issue will include the flow of funds. The flow of funds details the order in which collected revenues will be applied.
In a period of falling interest rates, a bond dealer would engage in all of the following activities EXCEPT:
A. raise prices in interdealer quote publications such as Bloomberg for municipal bonds
B. place "request for bids" in services such as Bloomberg on appreciated positions where the dealer has no current interest
C. bid for bonds to cover previously established short positions
D. buy put options on debt instruments to hedge existing short positions
The best answer is D.
In a period of falling interest rates, bond prices will be rising. Therefore, a dealer would raise his quoted prices in Bloomberg. If the dealer has appreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to limit losses due to rising prices. To hedge existing short positions against rising prices, the dealer would buy call options, not put options. Put options are used to hedge existing long positions from falling prices.
In a period of rising interest rates, a bond dealer would engage in which of the following activities?
I Lower prices in interdealer quote publications such as Bloomberg for municipal bonds
II Place "request for bids" in services such as Bloomberg on depreciated positions where the dealer has no current interest
III Bid for bonds to cover previously established short positions
IV Buy put options on debt instruments to hedge existing long positions
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is D.
In a period of rising interest rates, bond prices will be falling. Therefore, a dealer would lower his quoted prices in Bloomberg. If the dealer has depreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to take gains due to falling prices. To hedge existing long positions against falling prices, the dealer would buy put options. If prices fall, the dealer can "put" the bond at the contract price. Put options are used to hedge existing long positions from falling prices.
In a period of falling interest rates, a bond dealer would engage in which of the following activities?
I Raise prices in interdealer quote publications such as Bloomberg for municipal bonds
II Place "request for bids" in services such as Bloomberg on appreciated positions where the dealer has no current interest
III Bid for bonds to cover previously established short positions
IV Buy put options on debt instruments to hedge existing short positions
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is C.
In a period of falling interest rates, bond prices will be rising. Therefore, a dealer would raise his quoted prices in Bloomberg. If the dealer has appreciated bonds that he wishes to sell, he can place "Requests for Bids" for those bonds in Bloomberg. The dealer may bid (buy) bonds that he has previously sold short to limit losses due to rising prices. To hedge existing short positions against rising prices, the dealer would buy call options, not put options. Put options are used to hedge existing long positions from falling prices.
A selling dealer offering municipal bonds "firm for 1/2 hour with a 5 minute recall" means all of the following EXCEPT:
A. prices for bonds that are offered can't be changed for a stated period
B. the selling dealer has specified that he can recontact the buying dealer to reinstate a different price within a certain time period
C. the buying dealer can try and "round up" a customer for the bonds before the dealer actually purchases the bonds
D. the selling dealer has the right to rescind the price at any time
The best answer is D.
The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period that buying dealer can try and round up a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.
A municipal dealer who solicits a "Bid Wanted":
I must accept the first bid received
II need not accept the first bid received
III must have purchased the bonds prior to soliciting the bids
IV need not have purchased the bonds prior to soliciting the bids
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
A municipal dealer can trade without physically having the position. If a dealer is requesting bids (that is, the dealer wishes to sell bonds), the dealer must simply intend to deliver those bonds by settlement. There is no requirement that the dealer must have the bonds, or must have purchased the bonds, prior to soliciting bids. Furthermore, there is no requirement that the dealer accept the first bid. The dealer will accept the highest bid received (if the bid amount is acceptable).
A basis quote for a $10,000 municipal bond with one year left to maturity has just been raised by 20 basis points. The bond's change in price will be:
A. $20.00 increase
B. $20.00 decrease
C. $200.00 increase
D. $200.00 decrease
The best answer is B.
1 Basis Point = .01% = $.10 therefore 20 basis points equals .20% of par
.20% = .002 x $10,000 par = $20.
If interest rates rise by 20 basis points, this bond with 1 year to maturity should decrease in value by $20. Also note that this type of question can only be asked for a bond with 1 year to maturity. If there are many years to maturity, then discounted cash flow calculations are required, which are not tested.
Four revenue bonds have the same maturity. Which of the following will cost the greatest amount?
A. 5% bond quoted on a 5.25 basis
B. 5 1/4% bond quoted on a 5.00 basis
C. 5 1/2% bond quoted on a 5.50 basis
D. 5 1/4% bond quoted on a 5.50 basis
The best answer is B.
This choice is the only one where the nominal yield is higher than the basis. To lower the effective yield (basis) on the bond, the price must rise - this is the only premium bond of the four choices given. The other choices are either priced at par; or at a discount.
A basis quote for a $1,000 municipal bond with one year left to maturity has just been dropped by 20 basis points. The bond's change in price will be:
A. $2.00 increase
B. $2.00 decrease
C. $20.00 increase
D. $20.00 decrease
The best answer is A.
1 Basis Point = .01% = $.10, therefore 20 basis points equals .20% of par.
.20% = .002 x $1,000 par = $2.
If interest rates drop by 20 basis points, this bond with 1 year to maturity should increase in value by $2. Also note that this type of question can only be asked for a bond with 1 year to maturity. If there are many years to maturity, then discounted cash flow calculations are required, which are not tested.
A customer buys a 10% G.O. bond at 110. The issue is callable in 5 years at par and matures in 10 years. Which statement is TRUE?
A. The yield to call is higher than the yield to maturity
B. The yield to call is lower than the yield to maturity
C. The yield to call is the same as the yield to maturity
D. The nominal yield is lower than either the yield to call or yield to maturity
The best answer is B.
If a bond is purchased at a premium, there is a premium to be amortized over the life of the bond when computing yield to maturity. If the bond is called prior to maturity, the premium is lost "faster" and the yield to call falls below the yield to maturity. For a premium bond, the nominal yield is always higher than yield to call or yield to maturity (because the purchase price is more than par, the yield must drop below the stated rate of interest).
All of the statements are true about municipal dollar bonds EXCEPT dollar bonds
A. are usually term issues
B. can be a component of a large combination serial and term municipal offering
C. are actively traded in the secondary market
D. are quoted on a yield to maturity basis
The best answer is D.
Municipal dollar bonds are term issues that are quoted on a dollar basis. They are usually part of large combined serial and term bond offerings made by municipal issuers. These bonds are traded in the secondary market. Only serial bonds are quoted on a yield basis - dollar bonds, as their name implies, are quoted on a dollar price basis.
A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 1/2 points. After holding the bonds in inventory for a week, the dealer reoffers the bonds on a 9.10 basis. The dealer's approximate profit or loss on this transaction is:
A. loss of $150
B. loss of $400
C. gain of $150
D. gain of $400
The best answer is D.
The dealer purchases these bonds at par less 1 1/2 points, so the bonds were purchased at 98.5. Since these 9% coupon bonds were reoffered on a 9.10 basis, they must have been reoffered at a discount price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 9.10 reoffering yield. 9/9.10 = .989. Thus, the bonds were reoffered at an approximate price of .989% of par (note, this only works for long term maturities - not short term maturities).
The bonds were reoffered at a price that is .004% higher than the cost to the dealer (.985 cost versus .989 reoffer price). .004% x $100,000 face amount = $400 gain on the transaction. Note that "100M" of bonds is $100,000 face amount, where M = $1,000.
A customer purchases 10M of City of Los Angeles 7% G.O. bonds, maturing in 2041 at 90. Interest payments are Jan. 1st and Jul. 1st. The trade took place on Friday, May 2nd. How much accrued interest will the customer be required to pay the seller?
A. $0
B. $24.31
C. $231.38
D. $243.05
The best answer is D.
Interest accrues on municipal bonds on a 30 day month/360 day year basis, with interest accruing up to, but not including settlement date. The trade took place on Friday, May 2nd. Settlement occurs 2 business days after trade date. Therefore, settlement takes place on Tuesday, May 6th. The last interest payment was made on January 1st, so the buyer owes the seller:
January 30 days
February 30 days
March 30 days
April 30 days
May 5 days (up to, not including settlement)
125 days
125 days interest x $70 x 10 bonds / 360 = $243.05
Note that "10M" stands for $10,000 face amount of bonds (M is Latin for $1,000).
All of the following are necessary to calculate the total purchase price for a municipal bond traded on a yield basis in the secondary market EXCEPT:
A. coupon rate
B. yield to maturity
C. dated date
D. trade date
The best answer is C.
The dated date has no bearing on the calculation of the purchase price of a municipal bond. It is the date of issuance of the bonds, from which time interest will be paid. In order to calculate the bond's price, a bond calculator would be used. To do the calculation requires the coupon rate, yield to maturity, and years to maturity. The trade date is necessary to compute the amount of accrued interest that is due.
In the municipal trading market, a secondary market joint account could be formed for all of the following reasons EXCEPT to purchase:
A. a block of bonds offered AON in Bloomberg
B. securities offered in an Official Notice of Sale in the Daily Bond Buyer
C. a block of bonds offered by a bank
D. a block of bonds offered through another municipal trading firm
The best answer is B.
Municipal secondary market joint accounts are formed by a number of municipal firms to either acquire or sell large blocks of bonds in the secondary (trading) market. These accounts do not operate in the primary market. To bid on new issues of bonds announced in the Daily Bond Buyer, municipal bond firms join into syndicates to bid.
If a bond is trading at a discount, price volatility is greatest for a bond having:
I low interest rates
II high interest rates
III short term maturities
IV long term maturities
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
The basic truths about bond price volatility are:
The lower the coupon rate (the same as saying the lower the price of the bond), the greater the bond price volatility;
The longer the maturity, the greater the bond price volatility.
Thus, the most volatile bonds are deep discount, long maturity bonds.
Interest income from municipal bonds purchased by a resident of the issuing State is:
A. exempt from Federal, State and Local tax
B. exempt from Federal tax and subject to State and Local tax
C. subject to Federal tax and exempt from State and Local tax
D. subject to Federal, State and Local tax
The best answer is A.
The interest income from municipal bonds is exempt from Federal income tax; but is subject to State and Local tax. However, if a bond is purchased by a State resident, then the State exempts that issue from taxation as well.
The interest income earned on which of the following municipal bonds would be included in the alternative minimum tax computation?
A. School District Bond
B. Turnpike Revenue Bond
C. Industrial Revenue Bond
D. Water District Revenue Bond
The best answer is C.
The interest income derived from "non-essential use" private purpose revenue bonds is included in the alternative minimum tax computation. Industrial Revenue Bonds fall into this category. Public purpose bonds, such as G.O.'s, and public facility revenue issues are not subject to the alternative minimum tax (AMT).
An investor in the 28% tax bracket buys a 6% municipal bond quoted on an 8.00 basis. To calculate the equivalent taxable yield:
A. multiply 6% by 72%
B. divide 6% by 72%
C. multiply 8% by 72%
D. divide 8% by 72%
The best answer is D.
The formula for the equivalent taxable yield is:
Tax free yield / 100% -tax bracket =
equivalent taxable yield
8% / (100%-28%) = 8% / .72 = 11.11%
A customer residing in Connecticut that is in the 20% Federal tax bracket and the 5% State tax bracket wishes to make a bond investment with a minimum 10-year life. The customer also wants a high level of safety. The following 10-year bonds are available:
Yield
AAA Corporate Bond 5.50
U.S. Treasury Bond 4.00
AAA Federal Home Loan Bank Bond 4.50
AAA Connecticut Bond 3.50
The best recommendation for the customer is the:
A. U.S. Treasury bond
B. AAA Corporate bond
C. AAA Connecticut bond
D. AAA Federal Home Loan Bank bond
The best answer is B.
The rules on taxation of interest income received, generally, are:
Treasury/Agency Issues: Interest is subject to Federal Income tax, but is exempt from State and Local tax
Municipal Issues: Interest is exempt from Federal Income tax, and exempt from State and Local tax when purchased by a resident of that state
Corporate Issues: Interest is subject to Federal Income tax, and to State and Local tax
If the customer buys the Treasury bond yielding 4.0%, 20% of the yield will go to the Federal Government, so the after-tax yield is (.8 x 4.00%) = 3.20%.
If the customer buys the Federal Home Loan Bank bond yielding 4.50%, 20% of the yield will go to the Federal Government, so the after-tax yield is (.8 x 4.50%) = 3.60%.
If the customer buys the Corporate bond yielding 5.50%, 20% of the yield will go to the Federal Government and 5% to the State Government, so the after-tax yield is (.75 x 5.50%) = 4.125%.
If the customer buys the Municipal bond yielding 3.50%, there is no tax on the income received at either the Federal or State level, so the after-tax yield is 3.50%.
A customer residing in New York that is in the 35% Federal tax bracket and the 10% State tax bracket wishes to make a bond investment with a minimum 10-year life. The customer also wants a high level of safety. The following 10-year bonds are available:
Yield
AAA Corporate Bond 6.00
U.S. Treasury Bond 4.00
AAA Federal Home Loan Bank Bond 4.50
AAA New York Bond 3.50
The best recommendation for the customer is the:
A. U.S. Treasury bond
B. AAA Corporate bond
C. AAA New York bond
D. AAA Federal Home Loan Bank bond
The best answer is C.
The rules on taxation of interest income received, generally, are:
Treasury/Agency Issues: Interest is subject to Federal Income tax, but is exempt from State and Local tax
Municipal Issues: Interest is exempt from Federal Income tax, and exempt from State and Local tax when purchased by a resident of that state
Corporate Issues: Interest is subject to Federal Income tax, and to State and Local tax
If the customer buys the Treasury bond yielding 4.0%, 35% of the yield will go to the Federal Government, so the after-tax yield is (.65 x 4.00%) = 2.60%.
If the customer buys the Federal Home Loan Bank bond yielding 4.50%, 35% of the yield will go to the Federal Government, so the after-tax yield is (.65 x 4.50%) = 2.925%.
If the customer buys the Corporate bond yielding 6.00%, 35% of the yield will go to the Federal Government and 10% to the State Government, so the after-tax yield is (.55 x 6.00%) = 3.30%.
If the customer buys the Municipal bond yielding 3.50%, there is no tax on the income received at either the Federal or State level, so the after-tax yield is 3.50%.
A special assessment bond is:
A municipal bond in which funds are used to improve only a small portion of the community (ex: street lights)
The bond holder of a municipal issue is the:
Lender or creditor.
Equivalent taxable yield equation =
Tax Free Yield / (100% - Tax Bracket)
What is the right of rejection in a municipal bond issue?
The refusal by a municipal dealer to accept a delivery of bonds tendered by another municipal securities bond dealer
When analyzing a G.O. bond you would look at what ratios?
Collection ratio, debt per capita ratio, debt to value ratio
When analyzing G.O. bonds what ratio would you not look at? And why?
Debt service coverage ratio. They are used to evaluate revenue bonds, not GO bonds.
Industrial Development Bond
a revenue bond that is issued to finance commercial enterprises, such as the construction of a factory that can be operated by a private firm.
Industrial Development Revenue Bonds are backed by:
The corporate guarantor
The income source backing a special tax bond is usually excise taxes such as...
Gasoline, alcohol, sales tax, and tobacco taxes
Ad valorem taxes are
Property taxes that back GO bonds.
To ease temporary cash flow shortage, municipalities will issue:
TAN's, RAN's, TRAN's.
Municipal issuers offer bonds in the ____ market.
Primary.
New municipal group orders are filled when?
After resale orders but before designated orders.
From an issuer's standpoint, level debt service serial bonds have:
A. constant interest cost in the later years
B. constant principal repayment in the later years
C. declining interest payments equally offset by rising principal repayments
D. declining principal repayments equally offset by rising interest payments
The best answer is C.
Level debt service means that the issuer pays a constant yearly amount to service both the interest and principal repayment of a serial bond issue. Similar to a mortgage amortization schedule, part of the payment goes to principal repayment with the rest going to interest. In the early years, most of the payment is interest. In the later years, most of the payment is principal, since a majority of the bonds have been retired.
Short sale transactions are typical for which of the following?
I Listed options
II Common stock
III Municipal bonds
IV Treasury bonds
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible. Short selling (the sale of borrowed securities, with the purchase and replacement of the borrowed securities occurring later) is a strategy that allows the investor to profit in a falling market. Short selling can only be performed with actively traded securities (since ultimately the borrowed securities that were sold must be repurchased and replaced). Common stocks, listed options, and U.S. Government securities are all actively traded; and short selling of these securities is common.
All of the following securities are quoted on a yield basis EXCEPT:
A. Commercial Paper
B. Treasury Bills
C. American Depositary Receipts
D. Banker's Acceptances
The best answer is C.
Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned. American Depositary Receipts are not a money market instrument. They are essentially shares of a foreign company, traded domestically similar to equity securities. They are dollar price quoted in 1/8ths.
To smooth out cash flow, a municipality will issue all of the following EXCEPT:
A. BAN
B. RAN
C. TAN
D. TRAN
The best answer is A.
Municipalities issue TANs, RANs and TRANs to smooth out cash flow.
TANs are (Tax Anticipation Notes) to "pull forward" funds that will be collected as taxes in later months. For example, if taxes are due on April 15th, and it is now January 15th, and the municipality wishes to get funds at this time, it can issue 3 month TANs. When the taxes are actually collected, the proceeds are used to retire the TAN issue.
RANs (Revenue Anticipation Notes) are issued to "pull forward" revenues that are expected to be received by the municipality in the coming months. For example, the City of New York will receive a $200,000,000 payment from the Federal government on July 1st to support mass transit. It is now April 1st. The city can issue 3-month RANs and borrow against the upcoming revenue to be received from the Federal Government.
A TRAN is a combination Tax and Revenue Anticipation Note.
Municipalities issue BANs (Bond Anticipation Notes) to "pull forward" funds that will be collected from a later permanent bond sale. These are isolated events, since municipalities do not sell bonds every day (unlike collecting taxes and revenues). For example, a municipality expects to float a 20 year bond issue in 6 months. It can get the funds today by issuing 6 month BANs now. When the bond issue is floated, the proceeds are used to pay off the BANs.
Special assessment bond issues are paid from:
A. taxes levied upon all taxable property within the municipality, without limitation as to rate or amount
B. taxes levied upon all taxable property within a particular locality, not to exceed the benefit derived from the improvement
C. revenues pledged from the operation of a facility built with the proceeds of the issue
D. excise taxes placed upon the sale of either alcohol, tobacco, or fuel
The best answer is B.
A special assessment bond is one which is used to fund an improvement that benefits only a segment of the population; and only those people are charged taxes to pay for that improvement. Such taxes cannot exceed the value of the benefit received. This makes them totally different from general tax collections, such as ad valorem taxes, which have no such "tie-in".
All of the following are participants that offer municipal bonds in the secondary market EXCEPT:
A. bank dealers
B. general securities dealers
C. issuers
D. municipal broker's brokers
The best answer is C.
Municipal issuers offer bonds in the primary market. Issuers do not trade their outstanding debt. Bank dealers, general securities dealers and municipal broker's brokers all trade in the secondary market.
A bank qualified municipal issue is one where:
A. 0% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted
B. 20% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted
C. 80% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted
D. 100% of the interest expense the bank pays on deposits used to fund the purchase of the bonds can be deducted
The best answer is C.
A "bank qualified" municipal issue is an issue of $10,000,000 or less that has been designated by the issuer as a "bank qualified issue." To be bank qualified, it must be a public purpose (not private purpose issue). Any bank that buys the issue receives a tax benefit that is not available on all other municipal investments. The bank can deduct 80% of the interest expense it incurs on deposits used to fund the purchase of the bonds, while the interest income from the municipal issue is not taxable to the bank.
Bond appraisals are used in the municipal secondary market because:
I the market is thin
II the market is active
III trades are reported to a consolidated tape
IV trades are not reported to a consolidated tape
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Municipal dealers are often asked for bond appraisals by customers who wish to sell bonds. Because there is no active trading market for municipal bonds, last trading price information is not available. To get an idea of the value of the bond, the dealer will get prices of similar bonds and then give an estimated price to the customer. This is a likely sale price - not a firm quote.
Which of the following securities can be margined?
I Treasury bills
II Commercial paper
III Bankers' acceptances
IV Structured products
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is C.
Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds, and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.
Which of the following are TRUE statements regarding revenue bonds?
I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues
II Revenue bonds are only suitable for investors willing to assume a high level of risk
III The bonds may be double barreled with backing by ad valorem taxes
IV Issuance of the bonds is dependent on earnings requirements
A. I and II only
B. III and IV only
C. I, III, IV
D. I, II, III, IV
The best answer is C.
In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.
The formula for a municipality's collection ratio is:
A. taxes collected / taxes assessed
B. taxes assessed / taxes collected
C. taxes assessed * taxes collected
D. (taxes collected + assessed property values) / taxes assessed
The best answer is A.
One looks for a very high ratio (better than 95%), meaning that the municipality is truly collecting the taxes it is assessing. Remember that property tax collections are the source of income backing the municipality's general obligation bonds. If the town is not collecting the taxes it is assessing; then the town might default on its G.O. bonds.
Regarding auction rate securities, a failed auction will result if the:
I total par amount of sell orders received by the auction agent exceeds the total par amount of bids
II total par amount of buy orders received by the auction agent exceeds the total par amount of offers
III bid rates are lower than the Clearing Rate set for the auction
IV bid rates are higher than the Clearing Rate set for the auction
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Auction Rate Securities are either preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction. In order to have a successful auction for anything, there must be bidders (buyers) for the securities offered. A lack of bids (or no bids) will result in no auction, making Choice I correct.
The auction is conducted as a "Dutch Auction," where bids are accepted in minimum $25,000 increments to buy the amount of securities offered. The bids are accepted from the lowest interest rate on up to the highest interest rate, and bids are accepted until the total amount offered is sold. The highest interest rate bid that is accepted to complete the sale of the issue is called the "clearing rate" and the entire offering gets this interest rate for the next week.
Note that there is usually a maximum interest rate set on bids (otherwise, the issuer could be forced to pay exorbitant interest rates if the only bids received were at excessively high interest rates).
-If the interest rate bids received are at or below the maximum rate, then the auction is carried out as a Dutch Auction.
-If the interest rate bids are above the maximum rate (this implies that the issuer's perceived credit quality has deteriorated or that market conditions are excessively volatile and buyers are demanding much higher interest rates), then the auction has "failed" and the sellers (holders) of the securities will carry the positions to the next week, during which they will receive the maximum interest rate on those securities. Then another auction will be attempted.
Thus, the risk for the holder of an ARS is not that interest will not be earned; rather it is that the holder may be forced to continue to hold the security when that customer really wants to dispose of the position. This occurs when there is either a lack or bids; or the bids received are at interest rates that are higher than the maximum or clearing rate (which is the same as saying that the clearing rate is below the interest rate bid).
Which statements are TRUE when comparing traditional CDs to market index linked CDs?
I Traditional CDs have market risk if redeemed prior to maturity
II Traditional CDs do not have market risk if redeemed prior to maturity
III Market index linked CDs have market risk if redeemed prior to maturity
IV Market index linked CDs do not have market risk if redeemed prior to maturity
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
Market Index Linked CDs are a type of "structured product" that consists of a "zero-coupon" synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance.
Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor's 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This "early withdrawal" penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used.
Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.
U.S. Corporations issuing Eurodollar bonds are:
I subject to foreign currency exchange risk
II not subject to foreign currency exchange risk
III subject to filing with the SEC
IV not subject to filing with the SEC
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
Since these bonds are denominated in U.S. Dollars and payable in dollars and not the currency of the country in which they are sold, Eurodollar bonds are not subject to foreign currency exchange risk. Thus, if the foreign currency appreciates, it has no effect on the issuer, who is obligated to pay in dollars (not the more expensive foreign currency). Also, since these bonds are issued outside the U.S., the issue does not have to be registered with the SEC.
A municipality would defease its debt with which of the following?
I U.S. Government securities
II U.S. Government agency securities
III AAA Municipal securities
IV Bank certificates of deposit
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA municipals would not be used because their yield is lower than governments (since the interest is exempt from Federal income tax, while the others are taxable).
(Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)
All of the following could be overlapping debts EXCEPT:
A. school district debt
B. water district debt
C. county debt
D. state debt
The best answer is D.
An "overlapping debt" is the debt of another issuer, that is the ultimate responsibility of property taxpayer. Property taxes that are levied in a town consist of taxes to service that town's direct debt, plus taxes levied to service any larger districts or counties that "overlap" the town. State debt is not overlapping because it is paid from a different funding source (usually income or sales taxes); it is not paid from ad valorem taxes.
All of the following statements are true regarding municipal bonds that have been called EXCEPT:
A. interest ceases to accrue on the bonds
B. the call price sets a ceiling on the market price of the bonds
C. the holder may redeem the bonds at anytime
D. the bonds will continue to trade "and interest"
The best answer is D.
If a bond issue is called, interest ceases to accrue as of the date specified in the call. Thus, the bond will now trade "flat" - that is, without accrued interest. The call price will set a ceiling on the market price of the bond. Meaning, the market price of the bond will never go above the call price; if it did and the bonds were called, investors would suffer a loss. The bond can be tendered anytime thereafter, at which point the bondholder will be paid par value plus any specified call premium. The call price would not set the floor on the market price of the bonds as the market could go below the call price (which could occur if market interest rates started to rise).
A Prime Banker's Acceptance is:
I eligible for trading with the Federal Reserve
II ineligible for trading with the Federal Reserve
III negotiable
IV non-negotiable
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
A Prime BA is of sufficient quality to be an eligible security for Fed trading. All BAs are negotiable (tradeable) and the securities trade on a yield basis (at a discount to face value).
In order to determine whether a Brokered CD being recommended to a customer will qualify for FDIC insurance, the registered representative must know all of the following EXCEPT:
A. name of the bank issuing the CD
B. ownership title of the CD
C. face amount of the CD
D. call dates of the CD
The best answer is D.
Brokered CDs are sold by brokerage firms that are representing issuing banks. FDIC insurance of $250,000 maximum covers bank deposits - but only if the deposit is titled in the customer's name. If the CD is titled in the brokerage firm's name, then the insurance coverage would not apply! For example, if a customer wishes to buy a $75,000 CD, as long as the customer does not have deposits at the issuing bank in excess of $175,000 (thus not exceeding the $250,000 maximum FDIC coverage) and the CD is titled in the customer's name, then the CD would be FDIC insured.
Therefore, the bank name must be known because the customer gets only one coverage at that bank. The CD must be titled in the customer's name for the FDIC coverage to apply. Since coverage is a maximum of $250,000 per customer at each bank, the amount of the CD must be aggregated with any other customer deposits held at the bank to determine if the FDIC limit is exceeded. Call features are irrelevant to FDIC coverage.
Which statements are TRUE about Eurodollar bonds?
I The bonds are issued in bearer form
II U.S. corporate issuers are not subject to foreign currency risk
III Foreign corporate issuers are not subject to foreign currency risk
IV Trading is centered in the European market
A. I and II only
B. II and III only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
Eurodollar bonds are issued in bearer form outside the U.S. Trading is centered in London. Because the bonds are payable only in dollars, U.S. based issuers do not run any foreign currency risk. If foreign currency values rise, it has no effect on the issuer who pays in dollars. On the other hand, foreign issuers of Eurodollar bonds are subject to foreign currency risk. For example, if a British corporation issues Eurodollar bonds, and the British Pound declines in value relative to the dollar, then it will cost the British company more (in Pounds) to pay the debt service on the bonds.
The municipal bond counsel opines on all of the following EXCEPT:
A. validity
B. legality
C. feasibility
D. tax exempt status
The best answer is C.
The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render economic opinions, which is the same as rendering an opinion on feasibility of an issue.
An investor is seeking a municipal bond issue offering call protection. An issue having which features would NOT be an appropriate investment?
I Low stated interest rates
II High stated interest rates
III Low stated call premiums
IV High stated call premiums
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
An investor seeking call protection does not want the bonds to be called away. Most likely to be called are bonds with low call premiums and high interest rates. After calling the bonds, the issuer can refund the issue at lower rates, given that interest rates have fallen.
All of the following are sources of income that can be used for debt service on municipal revenue bonds EXCEPT:
A. User Fees
B. Special Taxes
C. Capitalized Interest
D. Lease Rentals
The best answer is C.
A revenue bond is defined as a debt where payment of interest and principal is derived from a source other than ad valorem taxes. Thus, revenue bonds can be paid off by lease rental fees, user fees, and special taxes (such as excise taxes). Capitalized interest is not an income source; rather it is part of the cost of a construction project that is included in the total financing needs when building a facility.
Which statements are TRUE about structured products?
I The bond component pays interest based on an index rate such as the performance of the NASDAQ 100 Index
II The interest rate paid is typically capped to an annual maximum rate
III The derivative component establishes the payment at maturity and protects principal
IV The security may be listed on a national securities exchange, but trading is typically very thin
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is D.
Structured products are securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies. There are many types of structured products, but generally they consist of a "bond" portion, which pays interest based on the performance of a well known index such as the S&P 500 Index or NASDAQ 100 Index. However, there is most often a cap on the maximum annual return. For example, if there is a 15% cap, and the NASDAQ 100 Index goes up by 18% that year, the structured product will only yield 15%. In addition, structured products have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity, protecting principal. These are often marketed as debt instruments, but that is not really the case. Structured products are created by many different brokerage firms and each firm's version is somewhat different. They can be exchange listed, though trading is typically pretty thin.
All of the following statements are true regarding Eurodollar bonds EXCEPT:
A. U.S. issuers of Eurodollar bonds are not subject to foreign currency risk
B. Eurodollar bond issues are sold all over the world, including the United States
C. Non-U.S. issuers of Eurodollar bonds are subject to foreign currency risk
D. Eurodollar bonds are denominated in U.S. currency only
The best answer is B.
Eurodollar bond issues are sold overseas (in Europe), but pay in U.S. Dollars. They are not registered with the SEC and thus, are not sold in the United States. Multinational U.S. issuers tap the Eurodollar bond market if interest rates are lower in this market than those available in the U.S. Foreign issuers may also sell Eurodollar issues. For U.S. issuers, there is no currency exchange risk, since payments are made in U.S. dollars. However, foreign issuers are exposed to currency risk, since they must convert their currency into U.S. dollars to make payments on Eurodollar issues.
New York City is issuing $500,000,000 of general obligation bonds paying interest on January 1st and July 1st of each year until maturity. The dated date of the issue is May 1, 2018. The first payment will be made on January 1st, 2019. A bondholder purchases the issue at the offering. How many months of interest will the first and second payments cover?
A. One month for the first payment; eight months for the second payment
B. Two months for the first payment; six months for the second payment
C. Six months for the first payment; six months for the second payment
D. Eight months for the first payment; six months for the second payment
The best answer is D.
Since the issue is dated on May 1st, interest starts accruing from this date. The first interest payment is made January 1st, covering 8 months. This is an "odd" first interest payment. Afterwards, interest payments are made every 6 months, on January 1st and July 1st.
A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive:
A. $500
B. $515
C. $1,000
D. $1,030
The best answer is B.
If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract. 103% of $500 = $515.
Interest income from which of the following securities is subject to State and Local tax?
A. Treasury Bonds
B. Federal National Mortgage Association Bonds
C. Federal Home Loan Bank Bonds
D. Puerto Rico Bonds
The best answer is B.
As a rule, interest income from U.S. Government securities is subject to Federal tax and exempt from State and Local tax. As a general rule, interest income from agency securities is subject to Federal tax and exempt from State and Local tax. However, the interest income from securities issued by the housing agencies that sell pass through certificates is fully taxable. These are:
Federal National Mortgage Association ("Fannie Mae")
Government National Mortgage Association ("Ginnie Mae")
Federal Home Loan Mortgage Corporation ("Freddie Mac")
Interest income received from bonds issued by territories or possessions is always triple exempt.
All of the following statements are true about "Build America Bonds" EXCEPT:
A. the issuer gets a federal tax credit equal to 35% of the stated interest rate on the issue
B. the interest is federally tax exempt
C. the bonds give municipal issuers access to the conventional corporate debt market
D. the proceeds of the bond issues can only be used for infrastructure improvements
The best answer is B.
Build America Bonds (BABs) were issued by municipalities in 2009 and 2010. They are taxable municipal bonds that get a 35% Federal interest rate subsidy and the bond proceeds must be used for capital improvements (this is part of the economic stimulus program after the 2008-2009 "great recession"). These bonds were meant to create jobs and make to it easier for municipalities to access the broader corporate debt market (which includes international investors who do not participate in the municipal market) for needed capital projects.
Industrial development bonds are backed by:
I the lease obligating the private user to rent the facility for the life of the bond issue
II the unconditional guarantee of the private user
III securities pledged as collateral by the private user
IV the faith and credit of the governmental issuer
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is A.
An industrial development bond is backed by the rents paid by a corporation using the facility built with the proceeds of the offering, and the guarantee of that corporation. However, there is no actual collateral pledged to back the issue. If the corporation defaults, the bondholders cannot claim any assets to satisfy the debt. Industrial bonds are not backed by G.O. (full faith and credit of a governmental issuer) pledge.
An ETN does NOT have which risk?
A. Market risk
B. Credit risk
C. Marketability risk
D. Reinvestment risk
The best answer is D.
An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. Thus, if the bank's credit rating is lowered, the value of the ETN will fall as well - so it has credit risk. ETNs are listed on an exchange and trade, so they have minimal marketability risk. ETNs have market risk - if market prices fall, their value will fall in the market. Finally, ETNs make no interest or dividend payments - so they do not have reinvestment risk. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates.
ETNs are "Exchange Traded Notes." They are an equity index linked structured product, that is listed and trades on an exchange. Because they trade, the liquidity risk aspect of structured products is eliminated. What is not eliminated, however, is credit risk. These products are only as good as the guarantee of the issuing bank. These products typically have a 7 year maturity and a lot can go wrong in 7 years.
If the issuing bank is downgraded, then it would be expected that investor interest in the ETN would fall. This should make the issue less marketable and also should cause the price to fall.
From an issuer's standpoint, level debt service serial bonds have:
A. constant interest cost in the later years
B. constant principal repayment in the later years
C. declining interest payments equally offset by rising principal repayments
D. declining principal repayments equally offset by rising interest payments
The best answer is C.
Level debt service means that the issuer pays a constant yearly amount to service both the interest and principal repayment of a serial bond issue. Similar to a mortgage amortization schedule, part of the payment goes to principal repayment with the rest going to interest. In the early years, most of the payment is interest. In the later years, most of the payment is principal, since a majority of the bonds have been retired.
Short sale transactions are typical for which of the following?
I Listed options
II Common stock
III Municipal bonds
IV Treasury bonds
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
Municipal bonds are generally not sold short because the trading market in each maturity is very thin, making short covering difficult, if not impossible. Short selling (the sale of borrowed securities, with the purchase and replacement of the borrowed securities occurring later) is a strategy that allows the investor to profit in a falling market. Short selling can only be performed with actively traded securities (since ultimately the borrowed securities that were sold must be repurchased and replaced). Common stocks, listed options, and U.S. Government securities are all actively traded; and short selling of these securities is common.
All of the following securities are quoted on a yield basis EXCEPT:
A. Commercial Paper
B. Treasury Bills
C. American Depositary Receipts
D. Banker's Acceptances
The best answer is C.
Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned. American Depositary Receipts are not a money market instrument. They are essentially shares of a foreign company, traded domestically similar to equity securities. They are dollar price quoted in 1/8ths.
Which of the following securities can be margined?
I Treasury bills
II Commercial paper
III Bankers' acceptances
IV Structured products
A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV
The best answer is C.
Because money market instruments are "safe," they can be margined - meaning that the brokerage firm can lend money against these securities held as collateral for the loan. Government securities, agency securities, investment grade money market instruments, investment grade corporate bonds, and listed stocks are the marginable securities. As a general rule, structured products cannot be margined because they are not readily transferable.
Which of the following are TRUE statements regarding revenue bonds?
I Yields for revenue bond issues are generally higher than yields for comparable G.O. issues
II Revenue bonds are only suitable for investors willing to assume a high level of risk
III The bonds may be double barreled with backing by ad valorem taxes
IV Issuance of the bonds is dependent on earnings requirements
A. I and II only
B. III and IV only
C. I, III, IV
D. I, II, III, IV
The best answer is C.
In order to issue revenue bonds, a feasibility study must be prepared and it must show adequate net revenues ("earnings") to service the debt before the bonds can be floated. A revenue bond can be double barreled to improve its safety by additionally backing the issue with the ad valorem taxing power of the issuer. Yields on revenue bonds are higher than that of comparable G.O. bonds because of generally higher risk. Revenue bonds are suitable for investors willing to take on low, medium or high risk. To evaluate credit risk on these issues, look at Moody's or Standard and Poor's ratings.
Regarding auction rate securities, a failed auction will result if the:
I total par amount of sell orders received by the auction agent exceeds the total par amount of bids
II total par amount of buy orders received by the auction agent exceeds the total par amount of offers
III bid rates are lower than the Clearing Rate set for the auction
IV bid rates are higher than the Clearing Rate set for the auction
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Auction Rate Securities are either preferred stock or bonds that have the dividend rate or interest rate reset at a weekly auction. In order to have a successful auction for anything, there must be bidders (buyers) for the securities offered. A lack of bids (or no bids) will result in no auction, making Choice I correct.
The auction is conducted as a "Dutch Auction," where bids are accepted in minimum $25,000 increments to buy the amount of securities offered. The bids are accepted from the lowest interest rate on up to the highest interest rate, and bids are accepted until the total amount offered is sold. The highest interest rate bid that is accepted to complete the sale of the issue is called the "clearing rate" and the entire offering gets this interest rate for the next week.
Note that there is usually a maximum interest rate set on bids (otherwise, the issuer could be forced to pay exorbitant interest rates if the only bids received were at excessively high interest rates).
-If the interest rate bids received are at or below the maximum rate, then the auction is carried out as a Dutch Auction.
-If the interest rate bids are above the maximum rate (this implies that the issuer's perceived credit quality has deteriorated or that market conditions are excessively volatile and buyers are demanding much higher interest rates), then the auction has "failed" and the sellers (holders) of the securities will carry the positions to the next week, during which they will receive the maximum interest rate on those securities. Then another auction will be attempted.
Thus, the risk for the holder of an ARS is not that interest will not be earned; rather it is that the holder may be forced to continue to hold the security when that customer really wants to dispose of the position. This occurs when there is either a lack or bids; or the bids received are at interest rates that are higher than the maximum or clearing rate (which is the same as saying that the clearing rate is below the interest rate bid).
U.S. Corporations issuing Eurodollar bonds are:
I subject to foreign currency exchange risk
II not subject to foreign currency exchange risk
III subject to filing with the SEC
IV not subject to filing with the SEC
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
Since these bonds are denominated in U.S. Dollars and payable in dollars and not the currency of the country in which they are sold, Eurodollar bonds are not subject to foreign currency exchange risk. Thus, if the foreign currency appreciates, it has no effect on the issuer, who is obligated to pay in dollars (not the more expensive foreign currency). Also, since these bonds are issued outside the U.S., the issue does not have to be registered with the SEC.
A municipality would defease its debt with which of the following?
I U.S. Government securities
II U.S. Government agency securities
III AAA Municipal securities
IV Bank certificates of deposit
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is C.
A municipality will defease its debt with securities of the highest credit rating, that provide the highest interest income to the municipality (since this interest income will be used to pay the interest expenses on the municipality's outstanding bonds that have been defeased). Acceptable securities to the bondholders are U.S. Governments, Agencies, and sometimes (rarely) bank certificates of deposit. AAA municipals would not be used because their yield is lower than governments (since the interest is exempt from Federal income tax, while the others are taxable).
(Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)
A Prime Banker's Acceptance is:
I eligible for trading with the Federal Reserve
II ineligible for trading with the Federal Reserve
III negotiable
IV non-negotiable
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
A Prime BA is of sufficient quality to be an eligible security for Fed trading. All BAs are negotiable (tradeable) and the securities trade on a yield basis (at a discount to face value).
The flow of funds set forth in a Trust Indenture:
I is typical for revenue bonds
II is typical for general obligation bonds
III states the order in which collected revenues will be disbursed
IV states the order in which the taxes collected will be disbursed
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is A.
Revenue bonds will have a trust indenture. In this trust indenture will be found the "flow of funds." The flow of funds details the priority of collecting and disbursing pledged revenues.
A municipal bond dealer quotes 10 year 3 1/2% Revenue bonds at 97 1/4 - 98. The dealer's spread per $1,000 is:
I $ .75
II $7.50
III 7.5 basis points
IV 75 basis points
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
The spread is .75 points, which is .75% of $1,000 par, which equals $7.50. $7.50 is the same as 75 basis points, since each basis point equals $.10.
A customer holds a very large, diversified portfolio of high grade municipal bonds with varying maturities. This customer has minimized which of the following risks?
I Default risk
II Legislative risk
III Marketability risk
IV Interest rate risk
A. I only
B. III and IV only
C. I, III, IV
D. I, II, III, IV
The best answer is C.
Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the interest income on the bonds. This risk cannot be diversified away. All the other risks can be diversified away. Default risk is minimized with a diversified portfolio; interest rate risk is minimized by mixing maturities. Marketability risk is also reduced by diversification, since it is unlikely that all the issues in the portfolio would become unmarketable at one time.
Generally, which statement is FALSE about market index linked CDs?
A. There can be a penalty applied to the principal amount of early withdrawals of funds
B. The annual rate of return may be capped to an amount that is lower than the actual index return
C. A market index linked CD can be redeemed at any time
D. A market index linked CD is FDIC insured
The best answer is C.
Market Index Linked CDs are a type of "structured product" that consists of a "zero-coupon" synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance.
Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor's 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This "early withdrawal" penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used.
Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.
Which of the following terms describe a special tax bond issue?
A. Self supporting
B. Non-self supporting
C. General obligation
D. Moral obligation
The best answer is B.
Special tax bonds are backed by taxes other than an ad valorem tax, such as liquor taxes, gasoline taxes, cigarette taxes or sales taxes. They are considered to be a non-self supporting debt since they are paid from tax collections. Self supporting debts are revenue bond issues that pay their own way from collected revenues.
Which of the ratings agencies listed below would most likely rate a municipal hospital revenue bond issue for credit risk?
A. Moody's
B. Morningstar
C. Fitch's
D. Best's
The best answer is A.
Moody's and Standard and Poor's are, by far, the largest of the ratings firms. Both rate municipal revenue bonds. Standard and Poor's rates issues if the issuer pays; Moody's rates issues whether the issuer pays or not - their stance is that they are Moody's Investors Services, and their ratings are a service to the investor (though paid for by the issuer). Fitch's is a much smaller ratings agency and concerns itself mainly with rating corporate issues. Morningstar rates mutual funds, not municipal bonds. Best's rates insurance companies, not securities.
Which of the following can issue Eurodollar bonds?
I Domestic Corporations
II Foreign Corporations
III U.S. Government
IV Foreign Governments
A. I only
B. II only
C. II and III
D. I, II, IV
The best answer is D. Eurodollar bonds are issued by U.S. corporations, foreign corporations, and foreign governments. The bonds are issued in foreign countries but are payable in dollars. The bonds give U.S. corporations access to foreign capital markets without having to assume foreign currency risk. The bonds give foreign corporations and governments access to investors who want to buy dollar denominated instruments, who might not normally buy the debt if it were payable in that country's currency.
Which of the following statements are TRUE about Eurodollar bonds?
I The bonds are issued in the U.S.
II The bonds are issued outside the U.S.
III The purchasers are U.S. residents
IV The purchasers are foreign residents
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is D.
Eurodollar bonds are issued outside the U.S. and are purchased by foreigners. These bonds are denominated in, and make payment in, U.S. dollars. The bonds are not registered for sale in the U.S.
Which statements are TRUE about Brokered CDs?
I The secondary market is active
II The secondary market is limited
III The market value of the CD will decline if interest rates rise
IV The market value of the CD is unaffected by interest rate movements
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
If interest rates rise after issuance, the value of the CD in the secondary market will fall (though not by much, since this is a short maturity). Most of these instruments are held to maturity, so the secondary market is very limited. Finally, brokered CDs qualify for FDIC insurance as long as the CD is titled in the customer's name.
A Capital Appreciation Bond (CAB) is:
I a general obligation bond
II a revenue bond
III issued at par
IV issued at a deep discount
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
A Capital Appreciation Bond (CAB) is a municipal zero coupon bond with a "legal" twist to it. A conventional zero coupon G.O. bond is counted against an issuer's debt limit at par value because the discount is treated as "principal." If a new issue discount bond is legally crafted as a CAB, then the principal counted against the issuer's debt limit is the discounted principal amount and the discount earned is considered to be interest income. The bond is purchased at the discounted price and then par is returned at maturity, with the 2 components of that par payment being the return of the discounted purchase price (the "principal" amount) and the accreted interest income.
When analyzing municipal general obligation bonds of different issuers, it is difficult to use the ratio of Overall Debt / Assessed Valuation because:
A. the ratio does not consider a municipality's ability to collect the taxes levied on all real property
B. municipalities differ in their method of computing overall debt
C. municipalities differ in their method of computing assessed value of properties
D. the ratio does not consider the management capabilities of municipal government
The best answer is C.
The ratio of Overall Debt to Assessed Value of Property is a more difficult measure to use when comparing municipal issuers for safety because municipalities have differing methods of computing assessed values of properties, and such assessments tend to be quite subjective. The computation of Overall Debt is consistent across municipalities, so this is not a problem. The other choices do not address the characteristics of the components of the ratio.
Which of the following securities has the highest level of credit risk?
A. General Obligation Bond
B. Industrial Development Bond
C. Equipment Trust Certificate
D. Mortgage Bond
The best answer is B.
An industrial development bond is backed by the rents paid by a corporation, and the guarantee of that corporation. However, there is no actual collateral pledged to back the issue. If the corporation defaults, the bondholders cannot claim any assets to satisfy the debt. Equipment trust certificates have lower credit risk because the equipment is pledged as collateral and mortgage bonds have lower credit risk because real property has been pledged as collateral. These assets can be claimed by the bondholders in the event of a default. General obligation bonds have lower credit risk because they are backed by broad based taxing power, compared to the backing of a single corporation (remember, corporations can, and do, go bankrupt; it is virtually impossible for states and towns to go bankrupt).
Which statements are TRUE about a Certificate of Participation (COP)?
I COPs are considered to be a general obligation of the issuer
II COPs are considered to be backed by a revenue pledge
III Payments to security holders are contingent on the governing body making an annual appropriation from budgeted funds
IV Payments to security holders are not contingent on the governing body making an annual appropriation from budgeted funds
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
As municipalities reached their debt limits with G.O. bond issuance, they found it harder and harder to get voter approval to raise limits to sell additional G.O. bonds (think of Proposition 13 in California that capped property taxes to almost no increase unless the property was sold). To get around this, the COP - Certificate of Participation - was invented and COP issuance is now greater than G.O. bond issuance in many states.
A COP is issued by a state entity where lease revenues are pledged to back the issue. The lease payments are received from a project such as a university dormitory, prison, municipal office building, municipal transit system, etc. The "difference" is that the lease payment is made based on the governing body making an annual appropriation from tax collections, and it is not "legally" obligated to do so, hence it is not really a bond. Rather, it is a security that gives the holder a share of "revenue" if the appropriation is made (which it will be, otherwise that issuer's credit rating would be trashed).
COP issuance has increased greatly over the years because they are easier to issue than G.O. debt (no pesky debt limits or voter approval to deal with) - but they are sold at a slightly higher yield, because they have more credit risk.
Two 10 year General Obligation bonds with the same maturity and credit rating are quoted on a 6.50 basis. One bond has a 7% coupon, while the other has an 8% coupon. If the quote is changed to 6.40%, which statement is TRUE?
A. The price of both bonds will change by the same percentage amount
B. The percentage change in price of the 7% bond will be more than the percentage change in price of the 8% bond
C. The percentage change in price of the 8% bond will be more than the percentage change in price of the 7% bond
D. No relationship exists between the price movements of the two bonds
The best answer is B.
Long term bond prices are more volatile than short term bond prices. Both of these bonds have the same maturity, so we cannot determine which bond's price will be more volatile from this fact. The price movement of discount bonds is more volatile than that for premium bonds. Both of these bonds are trading at a premium, so we cannot determine which bond's price movements will be more volatile from this fact. However, we do know that the lower the bond's coupon rate, the more volatile the bond's price movements will be as market interest rates move. Thus, the 7% coupon bond will be more volatile than the 8% coupon bond.
Banker's Acceptances:
I trade at a premium to par
II trade at a discount to par
III have a thin trading market
IV have an active trading market
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
Banker's Acceptances are time drafts on a bank used to finance imports and exports. BAs trade at a discount to their face amount until maturity. The trading market is rather thin.
The interest received from older "tax free" Industrial Development Bond (IDBs) issues is taxable if the holder of these bonds is:
A. a customer
B. a broker/dealer
C. the corporate lessee
D. a bank
The best answer is C.
The interest income earned from Industrial Development Bond Issues that were issued prior to 1986 was generally tax exempt. The lease payments made by the corporation are used to fund the interest payments made on the outstanding debt. These lease payments are tax deductible to the corporate lessee. If the corporation were to buy the outstanding bond issue, it would receive interest payments on the bonds that are tax free. Effectively, the corporation has taken a tax deduction for the lease payments; and has converted these payments into tax free interest income. The IRS does not allow this. If the purchaser of the bonds is a "substantial user" of the facility being leased, then the interest income received becomes taxable to the corporate lessee.
An analysis of general obligation bonds would include:
I examination of collection ratios
II evaluation of engineer's reports
III analysis of debt to value ratios
IV analysis of debt service coverage ratios
A. I and II only
C. I and III only
D. I, II, III, IV
The best answer is C.
General obligation bonds are backed by faith, credit, and taxing power of the issuer. To analyze these bonds, it is important to examine the issuer's collection ratio (taxes collected / taxes assessed) to ascertain if the issuer is truly collecting all the taxes necessary to service the debt. The ratio of debt to assessed value of property would also be examined, since most G.O. bonds are backed by ad-valorem (property) tax collections.
Engineer's reports are examined when evaluating a revenue bond issue (e.g., is that bridge feasible?) and are not relevant to G.O. bonds. Similarly, the ratio of pledged revenues to debt service requirements (debt service coverage ratio) is used to evaluate a revenue bond issue - not G.O. bonds.
Nominal quotes for municipal bonds are:
A. a firm price at which a transaction would take place
B. a likely price at which a transaction would take place
C. an indication of a price given for informational purposes only
D. prohibited to be disseminated to municipal market participants
The best answer is C.
A nominal quote is an approximation of a market price for a bond, given for informational purposes only. The dealer giving such a quote is under no obligation to trade at that price; or even near to that price.
Additional security backing a general obligation bond is provided if the issuer has:
A. a low ratio of Overall Net Debt to Assessed Value of Property
B. escrowed the issue to the maturity date
C. backed the issue by a pledge of unlimited ad valorem taxing power
D. received an unqualified legal opinion on the issue
The best answer is B.
The safest municipal issue is an "advance refunded" issue. The backing for these bonds is escrowed government and agency securities (and sometimes bank CDs). They are rated AAA.
While a normal general obligation bond is backed by tax collections and is a "non-self supporting debt" carried on the backs of the taxpayers, when a municipality "advance refunds" its G.O. bonds, it backs them with escrowed government and agency securities, making the debt self-supporting, so it no longer counts in that issuer's debt limit.
Issuers will advance refund their debt when interest rates have dropped, under the terms of the "defeasance" covenant included in the bond contract. This frees up their debt limit to sell new bonds at lower current market rates. Also note that if the bonds are callable and will be called at a call date using escrowed government or agency securities, then these are called "pre-refunded" bonds.
(Also note that the tax law changes that took effect at the beginning of 2018 banned municipalities from doing any more advance refundings or pre-refundings. However, all the bonds that have been advance refunded remain outstanding until they reach their maturity date, while those that have been pre-refunded remain outstanding until their first call date.)
All of the following statements are true about ETNs EXCEPT:
A. ETNs can be traded in the market like any other stock
B. ETNs offer an investment return tied to a benchmark index
C. ETNs are an equity security
D. ETNs are tax-advantaged
The best answer is C.
An ETN is an Exchange Traded Note. It is a type of structured product offered by banks that gives a return tied to a benchmark index. The note is a debt of the bank, and is backed by the faith and credit of the issuing bank. They are not an equity security - they are a debt instrument. ETNs are listed on an exchange and trade, so they have minimal liquidity risk. Finally, ETNs make no interest or dividend payments. Their value grows as they are held based on the growth of the benchmark index, with any gain at sale or redemption currently taxed at capital gains rates. Thus, they are tax-advantaged as compared to conventional debt instruments.
Eurodollar bonds:
I are issued in bearer form
II are issued in fully registered form
III pay interest which is subject to U.S. withholding taxes
IV pay interest which is not subject to U.S. withholding taxes
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is B.
Eurodollar bonds are not offered in the U.S. and are issued in bearer form (remember that the U.S. has made it illegal to issue domestic bearer bonds!) These bonds are not subject to withholding taxes (once again, because they are not offered in the U.S.)
A municipal dealer offers bonds to another dealer "firm for one-half hour with a five minute recall." This means that the:
I selling dealer can change the price at will
II selling dealer cannot change the price for one-half hour unless the buying dealer is recontacted
III buying dealer can solicit orders for the bonds before actually purchasing them
IV buying dealer cannot solicit orders for the bonds before actually purchasing them
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
The selling dealer offering the bonds "firm" means that for a stated time period the price will not be changed. These bonds are offered firm for one-half hour; during this time period that buying dealer can try and find a customer for the bonds before actually purchasing them. The selling dealer also specifies a "five minute recall." This means that during the half hour, the selling dealer can recontact the buying dealer to tell him that he has five minutes to buy the bonds at the offered price or else the quote will be changed.
Falling Water Authority "Flow of Funds" Statement 20XX
Water Charges: $9,000,000
Interest on Reserve Funds: $500,000
Gross revenues: $9,500,000
Operation and Maint: $6,500,000
Net Revenues: $3,000,000
Debt Service: $2,000,000
Addition to Reserves: $1,000,000
If the bonds were issued under a net revenue pledge, how much in funds were available to pay the bondholders for this year?
A. $3,000,000
B. $6,500,000
C. $9,000,000
D. $9,500,000
The best answer is A.
Under a net revenue pledge, only the net revenues (after operations and maintenance are paid) are pledged to bondholders. This water authority has $3,000,000 of net revenues, which would be the amount pledged to the bondholders under a net revenue pledge.
Municipalities would issue tax exempt commercial paper for all of the following reasons EXCEPT to:
A. meet a temporary cash shortage due to unforeseen extraordinary expenses
B. refund an outstanding bond issue
C. provide construction period financing that will be permanently financed by a future bond sale
D. smooth out collections of funds that are normally subject to seasonal fluctuations
The best answer is B.
Most municipalities finance short term needs through BANs (Bond Anticipation Notes), TANs (Tax Anticipation Notes), RANs (Revenue Anticipation Notes) and TRANs (Tax and Revenue Anticipation Notes). However, commercial paper could be used by a municipality to finance short term cash shortages caused by slow tax collections or unforeseen extraordinary expenses (these could also be financed by tax anticipation notes). Also, commercial paper could be used for an interim construction loan, because when a building is under construction, the long term financing may not yet be in place (of course, the municipality could also finance the construction through a bond anticipation note). Commercial paper cannot be used for long term financing such as a bond refunding.
An elderly customer that is currently invested in bonds for income is concerned about declining yields due to record low interest rates. He has contacted his registered representative and inquires about purchasing a reverse convertible note on a Blue Chip stock because it offers a higher yield. The customer should be informed that:
A. the note is safe because it is an obligation of a Blue Chip corporation
B. the note gives the customer the possibility of gains due to an equity price rise
C. he or she can potentially lose 100% of the principal amount due to a stock price decline
D. the "knock-in" price of the underlying security gives the customer the right to put the note back to the issuer at par at maturity
The best answer is C.
Reverse convertible notes were created for customers looking for enhanced yield in a low interest rate environment. Of course, any enhanced yield comes with higher risk. The note is linked to the price movements of an underlying stock (or very rarely, an underlying index). At maturity, the holder will receive par value, as long as the price of the reference stock is above the "knock-in" price (typically 70-80% of the initial reference price). On the other hand, if at maturity, the reference stock falls below the "knock-in" price, then the holder will receive the shares of stock. Thus, if the market price of the reference stock declines below the "knock-in" price, the customer receives the stock at maturity and not par value.
A reverse convertible note is a structured product that is an obligation of the issuing bank - not the corporation or the corporate securities on which the product is based. As such, the note only as good as the credit of the issuing bank. Furthermore, if the market price of the stock declines to, or through, the "knock-in" price, the customer receives stock at maturity and that stock could potentially be worthless. The customer should be made aware of all of these points.
Which statements are TRUE about Bloomberg?
I Bloomberg is published daily
II Bloomberg lists dealer offerings of municipal bonds in the secondary market
III Bloomberg shows quotes for any size
IV Bloomberg quotes are subject to prior sale or change in price
A. I and II only
B. III and IV only
C. I, II, IV
D. I, II, III, IV
The best answer is D.
All of the statements are true. Bloomberg is published electronically every day, and lists dealer offerings of municipal bonds in the secondary market. All quotes are "firm;" nominal (approximate) quotes cannot be given unless it is clearly stated that the quote is nominal. Quotes can be for any amount (any "size") of bonds; it is not required that they be for round lots only. The MSRB requires that all quotes that are disseminated be "bona fide." This means that, at the time that the quote was placed, the firm giving the quote is willing to trade at that price for the size quoted. However, all quotes are subject to prior sale or change in price.
Which statements are TRUE regarding repurchase agreements effected between the public and government securities dealers?
I The public customer is the seller of the government securities
II The public customer is the lender of monies
III The government dealer is the seller of the government securities
IV The government dealer is the lender of the monies
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
When a government dealer enters into a repurchase agreement with the public, the dealer is "getting liquid" by selling government securities to the customer, with an agreement to buy them back at a later date. Thus, the customer is lender of cash to the government dealer.
A customer in the 28% tax bracket is considering the purchase of a municipal bond yielding 8% or a corporate bond yielding 11.1%. Both bonds have similar maturities and credit ratings. Which statement is TRUE?
A. The effective yield on the municipal bond is higher
B. The effective yield on the corporate bond is higher
C. Both effective yields are equivalent
D. The coupon rates for each bond are necessary to determine the effective yield
The best answer is C. In order to compare the tax free municipal yield to the taxable corporate yield, the two must be equalized.
8% / (100% - 28%) = 11.1%
Since the corporate bond is yielding 11.1%, the equivalent municipal yield is the same.
A municipality has floated a $200,000,000 revenue bond issue. The annual level debt service requirement is $5,000,000. In the first fiscal year, the municipality has collected revenues of $8,000,000. The "Coverage Ratio" is:
A. $200,000,000 / $5,000,000
B. $8,000,000 / $5,000,000
C. $5,000,000 / $8,000,000
D. $13,000,000 / $200,000,000
The best answer is B. The Coverage Ratio is:
Collected Revenues / Annual Debt Service Requirement
$8,000,000 / $5,000,000 = 1.6 : 1
Note that the Annual Debt Service requirement consists of both interest expense for that year as well as scheduled principal repayments for that year.
Money market discounts are quoted on a:
A. yield basis
B. percentage of par basis in 1/8ths
C. percentage of par basis in 32nds
D. percentage of par basis in 64ths
The best answer is A.
Money market instruments are original issue discount obligations quoted on a yield basis that are priced at a discount to par (with the exception of negotiable certificate of deposit that are priced at par plus accrued interest). The discount from par is the interest earned.
A 10 year 8% municipal bond, quoted on a 6.00 basis, is priced at 105. A 10 year 7% municipal bond, quoted on a 6.00 basis, is priced at 101. What is the price of a 10 year, 7.5% municipal bond, quoted on a 6.00 basis?
A. 103
B. 104
C. 104.10
D. 105.20
The best answer is A.
This question is asking for the following:
8% Coupon 6.00 Basis 105
7.5% Coupon 6.00 Basis ?
7% Coupon 6.00 Basis 101
The difference in price between the 7% and 8% bonds is 4 points. The 7.50% bond is 50% of the way from 7%. 50% x 4 points difference = 2 point price increment from the 7% price. 101 + 2 = 103 price for the 7.5% bond.
All of the following would be found in a municipal bond resolution EXCEPT:
A. the issuer's duties to the bondholders
B. the nature of the obligation
C. any restrictive covenants to which the issuer must adhere
D. any costs to be paid by the issuer in connection with issuing the bonds
The best answer is D.
The bond resolution (or bond contract) is the contract between the issuer and the bondholder. It spells out the nature of the obligation; the issuer's duties to the bondholders; and any restrictive covenants to which the issuer must adhere. Any costs that the issuer incurs to sell the bonds has no bearing on the bond contract, since the bondholder is not involved in these expenses - they are solely the responsibility of the issuer.
A "double barreled" municipal issue has:
I primary backing of a general obligation pledge
II primary backing of a revenue pledge
III secondary backing of a general obligation pledge
IV secondary backing of a revenue pledge
A. I and III
B. I and IV
C. II and III
D. II and IV
The best answer is C.
A "double barreled" bond is a municipal revenue bond whose principal and interest payments are backed by a revenue pledge; however, if the revenues are insufficient to cover the debt service requirements, the municipality will use its ad valorem taxing power to meet the deficit.
When comparing a Variable Rate Demand Obligation (VRDO) to an Auction Rate Security (ARS), which statement is FALSE?
A. Both are long-term bonds that have interest rates reset weekly or monthly
B. Both are subject to the credit risk of the issuer
C. Both have tender options
D. Both are marketed by broker-dealers
The best answer is C.
Both variable rate demand obligations (VRDOs) and auction rate securities (ARSs) are long-term bonds that have the interest rate reset weekly or monthly, giving the issuer the advantage of lower short-term interest rates on a long-term bond issue. The interest rate on a VRDO is typically set to a market index and the issue can be put back to the issuer at the reset date. With an ARS, the interest rate is reset by Dutch auction, and the owner can only sell at the auction to another buyer - there is no embedded put option.
Both are subject to credit risk and both are marketed by broker-dealers.
A municipal secondary market joint account would be formed to bid on which of the following municipal bond offerings?
I General obligation bonds offered through competitive bid via an Official Notice of Sale
II Turnpike authority revenue bonds offered through a municipal broker's broker
III Sewer assessment bonds offered through a dealer in Bloomberg
IV Pollution control bonds offered through a dealer in Bloomberg
A. I only
B. II and III only
C. II, III, IV
D. I, II, III, IV
The best answer is C.
Municipal secondary market joint accounts are groups of municipal dealers that are formed to buy or sell blocks of municipal bonds in the secondary (trading) market. To buy a new issue (primary market), a syndicate would be formed, making Choice I incorrect. The other transactions are all effected in the secondary market and could all be performed by municipal secondary market joint accounts.
Which of the following are TRUE regarding municipal bonds offered out "firm" by one dealer to another?
I The buying dealer is able to renegotiate the price
II The buying dealer can sell the bonds before actually purchasing them
III The selling dealer will not change the price for a specified time period
IV The buying dealer has control over the bonds for a specified time period
A. I and II only
B. III and IV only
C. II, III, IV
D. I, II, III, IV
The best answer is C.
A quote offered out "firm" means that the selling dealer will not change the price for the time period specified. During this time period, the buying dealer has control over the bonds and can sell the bonds before actually purchasing them.
Municipal bonds would not be an appropriate investment for which of the following?
A. Individual Retirement Accounts
B. Individuals
C. Casualty Companies
D. Bank Holding Companies
The best answer is A.
It makes no sense to place "federally tax exempt" municipal bonds into a "tax deferred vehicle" such as an IRA or Keogh account. Since the account is tax deferred, one would place securities earning the highest "before tax" return, such as corporates or governments, into the account. Tax is due only when the positions are liquidated and the funds withdrawn from the account. Individuals in high tax brackets buy municipal bonds for their federal income tax exemption; insurance companies buy municipal issues as part of their portfolios; and banks buy municipals as part of their investment portfolio (for example, they purchase "bank qualified" municipal issues that give the bank a large tax advantage).
All of the following can issue Eurodollar Bonds EXCEPT:
A. Domestic Corporations
B. Foreign Corporations
C. U.S. Government
D. Foreign Governments
The best answer is C.
Eurodollar bonds are issued by U.S. corporations, U.S. State and local municipalities, foreign corporations, and foreign governments. The bonds are issued in foreign countries but are payable in dollars. The U.S. Government does not issue Eurodollar Bonds.
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