03.3 Municipal Securities

Question 1

The REVDEX consists of:

I. 20 revenue bonds
II. 25 revenue bonds
lll. With 20-year maturities
IV. With 30-year maturities

A. II, III
B. I, III
C. I, IV
D. II, IV

Answer 1

II, IV

Rationale:
The GO Index is 20-20. The Revdex is 25-30. 25 bonds with 30-year maturities. Quoted in terms of yield, so if the index is up, prices are down and vice versa.

Question 2

What is true of a trust indenture for a revenue bond?

A. It contains the flow of funds statement and other covenants
B. It is required under the Trust Indenture Act of 1939
C. It is required under the Trust Indenture Act of 1933
D. It is a requirement for all general obligation bonds issued post-1972

Answer 2

It contains the flow of funds statement and other covenants

Rationale:
The Trust Indenture Act of 1939 covers corporate, not municipal, bonds. The trust indenture is included in most revenue bonds because it makes it easier to sell the bonds to the public but is not a requirement under securities law. As a bondholder, it’s nice to know there are promises/agreements that the issuer must live up to in the name of paying you back the principal and interest on the loan/bond. Those promises include the flow of funds statement, whether it’s an open or closed-end issue, and the basic rate, maintenance and other covenants.

Question 3

Whichofthefollowingmunicipal securities would be quoted in terms of price as a percentage of par?

A. Serial bonds
B. Revenue bonds
C. Term bonds
D. General obligation bonds

Answer 3

Term bonds

Rationale:
Term bonds are quoted in terms of dollar price. The serial maturities are quoted in terms of yield or “basis.”

Question 4

The term used to denote the difference between the amount bid for the issue and the reoffering price is the:

A. Spread
B. Straddle
C. Re-allowance
D. Additional takedown

Answer 4

Spread

Rationale:
The spread is the difference between what the underwriters pay the issuer for the bonds and what they sell them to the public for. If they give the issuer $990 per bond and sell the bonds for par, that is a $10 spread that is divvied up among the underwriters.

Question 5

According to MSRB rules, municipal dealers must do which of the following?

A. Secure the best available price for their retail customers
B. Disclose the spread/re-offering yield when re-offering issues awarded via competitive bidding
C Secure the best available price for all institutional customers
D. Disclose order priority upon customer request

Answer 5

Disclose order priority upon customer request

Rationale:
Eliminate anything that says they have to get the “best price.” They don’t. Just a fair and reasonable price, whether for institutional or retail customers.

Question 6

The MSRB requires that municipal dealers disclose control relationships:

A. To retail customers only
B. In all customer transactions
C. None of the choices listed
D. To institutional buyers only

Answer 6

In all customer transactions

Rationale:
Keep it simple; control relationships must be disclosed.

Question 7

When calculating a capital gain or loss on a municipal bond purchased at a premium, the premium is:

A. Amortized
B. Accreted
C. Multiplied
D. Disclosed

Answer 7

Amortized

Rationale:
Premiums are amortized (stepped down); original issue discounts are accreted (stepped up). In both cases we adjust the price of the bond toward par.

Question 8

All of the following information is provided on a trade confirmation for a municipal bond except:

A. Maturity date
B. Issue date
C. Tax-equivalent yield
D. Lower of YTM, YTC

Answer 8

Tax-equivalent yield

Rationale:
Not everyone is in the same tax bracket, and state taxes also kick in, at different rates.

Question 9

Members of the selling group buy bonds from the syndicate at the:

A. Additional takedown
B. Par
C. Total takedown
D. Concession

Answer 9

Concession

Rationale:
They make the concession; another way of saying it is that they buy at the concession.

Question 10

A municipal securities dealer may do all of the following except:

A. Indicate more than one market while participating in a joint account
B. Submit competitive bids in states where the principal(s) reside(s)
C. Exceed its participation in a new offering
D. Sell bonds to retail customers at a 4% markup

Answer 10

Indicate more than one market while participating in a joint account

Rationale:
To “indicate more than one market while participating in a joint account” is a fancy way of saying that the underwriters are using different prices for different investors.

Question 11

Which of the following terms would not relate to municipal
bond underwritings?

A. Firm commitment
B. Best efforts
C. Negotiated
D. Standby

Answer 11

Standby

Rationale:
Standby underwritings are firm commitments for stock offerings, not municipal securities.

Question 12

ABC Broker-Dealers has just informed a family of municipal bond mutual funds that the fund should award more trading business to ABC based on the fact that ABC sold more of the fund’s shares than any other broker-dealer. This action is:

A. Prohibited unless approved in advance by a principal
B. Permissible as long as ABC did,’m fact, sell a minimum number of fund shares
C. Not covered under current MSRB rules
D. A violation of the MSRB’s anti-reciprocity rule

Answer 12

A violation of the MSRB’s anti-reciprocity rule

Rationale:
FINRA and MSRB are on the same page here—a broker- dealer can not solicit trading business from a mutual fund in exchange for selling the fund shares to investors.

Question 13

Why do some municipalities maintain a debt limit?

A. To set a ceiling on the maximum amount that may be borrowed annually
B. To satisfy the reporting requirements under the Securities Exchange Act of 1934
C. To protect residents against excessive taxes
D. To improve the marketability on revenue bond issues

Answer 13

To protect residents against excessive taxes

Rationale:
Taxes pay back the bondholders, so the municipality doesn’t want to issue too many bonds, which would require too many taxes on the residents. The amount of GO debt they have at any one time is often stipulated by their self-imposed debt limit.

Question 14

The bid form submitted by a syndicate is:

A. Defined as an uncompleted contract to purchase municipal bonds
B. Required by the Securities Act of 1933
C. Also called the “Official Notice of Sale”
D. Often referred to as the “Trust Indenture”

Answer 14

Defined as an uncompleted contract to purchase municipal bonds

Rationale:
A good one to just memorize and keep moving.

Question 15

All of the following information is material to the selection of a municipal bond investment except:

A. Maturities
B. Denominations of the bonds
C. Customer’s state of residence
D. Credit quality

Answer 15

Denominations of the bonds

Rationale:
Denominations ($1,000 or $5,000) are not considered material factors. Rating, maturity, yield, and state of residence are material to the recommendation of municipal securities.

Question 16

What is true of a separately identifiable division of a bank that acts as a municipal securities dealer?

A. It is illegal under FINRA regulations
B. It is often called a “bank dealer”
C. It is exempt from the Anti-Fraud Provisions of the Act of 1934
D. It is illegal under MSRB regulations

Answer 16

It is often called a “bank dealer”

Rationale:
Nobody’s exempt from anti- fraud rules. Nothing illegal about this setup, either. It’s just a separately identifiable division of a bank that deals in municipal securities.

Question 17

After completing a secondary market transaction for a customer, a municipal securities dealer must provide all of the following information except:

A. Customer’s name and address
B. Whether the firm acted as agent or principal
C. Firm’s name and address
D. Price the firm paid for the bonds

Answer 17

Price the firm paid for the bonds

Rationale:
How could we exclude any of the other three from the confirmation? The municipal dealer does not have to disclose the price they paid for the bond. They do disclose commissions when acting as a broker, and always disclose whether they acted as a dealer or a broker on the transaction. Can’t be both on the same transaction.

Question 18

In a municipal bond underwriting, the additional takedown + selling concession =

A. Total spread
B. Additional takedown
C. Total takedown
D. Re-allowance

Answer 18

Total takedown

Rationale:
A member of the syndicate makes the additional takedown for the bonds they’re responsible for and makes the selling concession whenever they sell a bond themselves (as opposed to passing it off to the selling group). Those pieces together are called the total takedown, which is the most that a syndicate member other than the manager can make on any sale of a municipal security. The manager can make the total spread, because the manager always keeps the little manager’s fee on any bond they sell, or any bond anybody sells. It’s good to be manager.

Question 19

If a municipal bond offering is oversubscribed, which of the following documents would detail the priority for acceptance of orders?

A. Legal opinion
B. Agreement among underwriters
C. Bond resolution
D. Indenture

Answer 19

Agreement among underwriters

Rationale:
The underwriters have to come to agreement on this, as well as the spread, the liability for unsold shares, etc. They come to an agreement among themselves, and they go ahead and call the document the agreement among underwriters. And, since everything needs at least two names, they sometimes refer to it as the syndicate letter.

Question 20

If a customer purchases an OID municipal bond, how will the difference between the purchase and redemption price be treated for tax purposes if held to maturity?

A. None of the choices listed
B. Long-term capital gain
C. Ordinary income
D. Short-term capital gain

Answer 20

None of the choices listed

Rationale:
For an OID you get to add to/accrete your cost base every year you hold the bond. It’s a tax-free municipal security, so you pay no tax on that increase, which represents the interest income you’ll receive at maturity. By the time the thing matures, your cost base has been stepped up/accreted to the par value, so both your proceeds and cost base are par. Zero gain or loss.

Question 21

A municipal securities dealer is acting as a financial advisor to the city of Flint, Michigan. If the dealer wants to participate in a competitive, sealed bid underwriting, all of the following must occur except:

A. The dealer must disclose the advisory relationship on customer confirmations
B. The dealer must officially terminate the advisory relationship
C. The dealer must get permission from the issuer to participate in a syndicate
D. The dealer must abide by suitability requirements when recommending the bonds

Answer 21

The dealer must officially terminate the advisory relationship

Rationale:
They only have to terminate if they’re doing a negotiated underwriting, which is for most revenue bonds.

Question 22

What should a registered representative consider when recommending a municipal bond to a customer?

A. Neither
B. Customer’s state of residence
C. Customer’s risk tolerance
D. Both

Answer 22

Both

Rationale:
Both factors are relevant.

Question 23

What is a “bond appraisal?”

A. A likely price at which a particular municipal bond would trade
B. A firm price that the municipal dealer would pay for the bond
C. Credit rating for a revenue bond only
D. Credit rating, such as AA+ provided by S&P or Moody’s

Answer 23

A likely price at which a particular municipal bond would trade

Rationale:
Just giving you an appraisal, like an antique dealer would do.

Question 24

Which of the following statements concerning OlD’s are true?

I. The discount must be accreted
II. The discount must be amortized
III. If held to maturity, there will be no capital gain or loss

A. I only
B. II only
C. I, III
D. II, Ill

Answer 24

I, III

Rationale:
For an OID you get to add to/accrete your cost base every year you hold the bond. It’s a tax-free municipal security, so you pay no tax on that increase, which represents the interest income you’ll receive at maturity. By the time the thing matures, your cost base has been stepped up/accreted to the par value, so both your proceeds and cost base are par. Zero gain or loss.

Question 25

Ifyourcustomerisconcerned about tax preference items for AMT, you would least likely recommend:

A. GO bonds
B. School bonds
C. Public purpose bonds
D. Private purpose bond

Answer 25

Public purpose bonds

Rationale:
Private purpose bonds don’t get the favorable tax treatment from the IRS that public purpose/essential/GO bonds receive. So, if the customer pays AMT—and most municipal security investors do—keep them out of private
purpose bonds. Put them in GO’s especially school bonds. Interest on private purpose municipal securities are tax preference items” along with “accelerated depreciation” and can add taxes an investor was really hoping to avoid.

Question 26

What is the difference between NIC and TIC?

A. TIC includes the time value of money
B. TIC produces a lower cost of borrowing
C. TIC is required by the IRS
D. NIC includes the time value of money

Answer 26

TIC includes the time value of money

Rationale:
TIC-TOC, like a clock. TIC includes the TIME value of money.

Question 27

Allofthefollowinggiftsfrom municipal securities representatives would probably adhere to MSRB rules except:

A. 1 bottle of wine worth $80 per bottle to 50 representatives of another firm
B. A gift of a box seat ticket for a baseball game to a principal at another firm
C. A gift of a single-game box seat ticket to a principal at the employing firm
D. 1 bottle of $500-per-bottie wine to a principal of another firm

Answer 27

1 bottle of $500-per-bottie wine to a principal of another firm

Rationale:
The maximum gift that may be given by an MSRB/FINFIA member or associated person is $100 per person per year. So, the gift of wine worth. S500 to one person would be a violation. Had the tickets been season tickets, that would have been a violation. Occasional tickets to sporting events, concerts, plays, etc. are okay. Season tickets are going to exceed the S100 limit in virtually all cases.

Question 28

Straight-line amortization is used to determine:

A. Annual decrease to an OlD’s cost basis
B. Annual increase to a premium bond’s cost basis
C. Annual decrease in a premium bond’s cost basis
D. Annual increase in an OlD’s cost basis

Answer 28

Annual decrease in a premium bond’s cost basis

Rationale:
When an investor buys a bond at a premium, she will lose that premium at maturity. So, she takes that loss evenly, year by year on paper. If she’s going to lose $200 by purchasing a bond @120, and the bond matures in 10 years, she just amortizes (loses on paper) 1/10th of that each year, or $20.

Question 29

All of the following information is included in a municipality’s Official Notice of Sale except:

A. Dated date
B. Name of the bond counsel
C. Term or serial maturity
D. Agreement among underwriters

Answer 29

Agreement among underwriters

Rationale:
The agreement among underwriters is just what it sounds like—an agreement among the underwriters. The Notice of Sale alerts potential underwriters that the municipality is seeking bids for a GO issue.

Question 30

All of the following eventualities represent reasons to invoke a catastrophic call provision for a municipal bond except:

A. Interest rates rise sharply
B. Tornado destroys the sports complex
C. Property is condemned
D. Tax-exempt status is lost

Answer 30

Interest rates rise sharply

Rationale:
A catastrophe occurs when the bonds lose their tax-exempt status or when the facility is destroyed. Rising interest rates might make the market value of the bonds drop, but that’s not a catastrophe, and certainly not to the issuer, who is simply making those flat interest payments every six months, regardless of bond market prices.

Question 31

A credit analyst would include which of the following when
| assigning a rating to a municipality’s general obligation bond?

I. Direct debt
II. Overlapping debt
III. Defeased debt

A. I, II, III
B. I, II
C. I
D. II

Answer 31

I, II

Rationale:
“Defeased debt” would be bond issues whose debt service has already been covered by funds locked up temporarily in escrow. So, if the debt has been covered already, why include it when assigning a credit rating on a totally separate bond issue?

Question 32

Which of the following are true statements concerning callable municipal bonds?

I. Callable bonds yield less than non-callable
II. Call premiums tend to increase over time
III. Call premiums tend to decrease over time
IV. Call prices are stated as a percentage of the market price to be returned to the investor

A. I only
B. Ill only
C. IV only
D. I, II only

Answer 32

Ill only

Rationale:
If the investor is willing to let the issuer re-finance/call the bonds, the investor gets a higher yield, not a lower yield.

Question 33

Where would the flow of funds statement be found for a revenue bond?

A. Prospectus
B. Bond resolution
C. Notice of sale
D. Legal opinion

Answer 33

Bond resolution

Rationale:
The notice of sale is an announcement trying to attract underwriters.

Question 34

A municipal securities principal must approve which of the following?

A. Legal opinions
B. Official statements
C. Abstracts/summaries of official statements
D. Preliminary official statements

Answer 34

Abstracts/summaries of official statements

Rationale:
The principal at a municipal securities firm would only have to approve material prepared by the firm. The issuer prepares the preliminary official statement and the final official statement. The bond counsel renders a legal opinion—those folks would get mighty miffed if somebody even suggested that their opinion needed to be “approved” by somebody.

Question 35

Which document contains the amount of the takedown and concession?

A. Bond indenture
B. Syndicate letter
C. Official notice of sale
D. Official statement

Answer 35

Syndicate letter

Rationale:
You had to be mighty tempted to associate “takedown” and “concession” with a choice that said “syndicate letter,” right?

Question 36

The difference between the two bond prices below represents a difference of:

Bid: 97 1/2
Offer: 98

I. 500 basis points
II. 50 basis points
III. $50
IV. $5

A. II only
B. II, IV only
C. I, III only
D. I only

Answer 36

II, IV only

Rationale:
Remember that bond points are $10. Any fraction, then, is a fraction of $10. Half of one bond point is $5, then. Next, if you multiply the par value of a bond by 1 basis point (.0001) you get 10 cents. $5, then, would be 50 basis points.

Question 37

Which of the following terms are associated with municipal revenue bonds?

A. Ad valorem
B. Negotiated underwriting
C. Voter approval by referendum
D. Coterminous debt

Answer 37

Negotiated underwriting

Rationale:
Revenue bonds are usually underwritten on a negotiated basis.. “Coterminous” is a term used only for general obligation debt.

Question 38

A variable-rate municipal bond would most likely:

A. Get a higher credit rating
B. Present decreased interest rate risk to the investor
C Present increased interest rate risk to the investor
D. Receive the SEC’s approval for sale

Answer 38

Present decreased interest rate risk to the investor

Rationale:
If a bond pays 5%, whenever interest rates on new bonds rise, they make the existing bond—paying its flat 5%–look less attractive all of a sudden and down goes the price. Ah, but what if we made the rate of return variable? As interest rates on new bonds rise, so does your rate of return. Now your bond should not suffer a drop in price, since you’re receiving what investors in new debt securities are receiving.

Question 39

Which of the following statements concerning municipal securities advertising is true?

A. Preliminary official statements must be approved by a municipal securities principal
B. Copies of advertising must be filed with the MSRB within 15 days of first use
C. Official statements must be promptly approved by a municipal securities principal
D. Copies of advertising are filed for three years by a principal

Answer 39

Copies of advertising are filed for three years by a principal

Rationale:
Advertising is approved by the firm preparing and using it, and the principal, after signing off on it, keeps it on file for three years.

Question 40

Municipal bonds offered in the primary market are currently available in which of the following forms?

A. Neither
B. Both
C. Bearer
D. Registered as to principal only

Answer 40

Neither

Rationale:
The primary market is where new issues come from. New issues haven’t been issued in bearer or registered as to principal only form since the early 1980’s. Some of those bonds are still circulating in the secondary market, but they don’t get issued (primary market) that way anymore.

Question 41

When an issuer determines the winning bid, which of the following is most significant in determining the winning syndicate?

A. Total spread
B. Net interest cost
C. Re-allowanc
D. Concession

Answer 41

Net interest cost

Rationale:
What does any borrower care about? How much is it going to cost me to borrow this money? Net or True Interest Cost.

Question 42

A municipal securities representative may give a gift of $150 to:

A. Neither
B. Both
C. A principal at another firm
D. A customer

Answer 42

Neither

Rationale:
The limit is $100.

Question 43

What is the purpose of the fidelity bond required under MSRB rules?

A. Protects customer against sharp market declines
B. Protects against theft/loss/misplacement of a security
C. Protects customer against sharp upward spikes in interest rates
D. None of the choices listed

Answer 43

Protects against theft/loss/misplacement of a security

Rationale:
A “fidelity” bond protects against the theft/embezzlement/loss of a customer’s securities, which
would certainly represent IN fidelity, or “broken trust.”

Question 44

A municipal securities dealer buys a bond @ 98 3/8 and immediately sells it @99 for a profit of:

A. $5.80
B. $62.50
C. $5.00
D. $6.25

Answer 44

$6.25

Rationale:
The difference is 5/8’s, right? What is 5/8 of $10? $6.25.

Question 45

What is a “workable indication”

A. Either choice given
B. A likely bid
C. None of the choices listed
D. An indication given by the issuer that a particular syndicate is likely to win a competitive sealed bid?

Answer 45

A likely bid

Rationale:
When a dealer gives a “workable indication,” they have expressed a likely bid, or a likely price at which someone could sell the bond to them. It’s not a firm quote yet; we’re just getting in the ballpark.