Additional Questions Flashcards
The rate charged to generate property taxes
Millage Rate
Bond supported from both taxes and revenues
Double-Barreled
Document that provides insight into the tax exempt status of the issuer
Legal Opinion
The covenant stating that the fees charges will be sufficient to cover expenses
Rate Covenant
A call that may be used to retire debt due to the destruction of a facility
Catastrophe Call
The priority used for the payment of debt service on revenue bonds
Flow of Funds
MIG 1 - MIG 3
Ratings for Municipal Notes: MIG 1 through MIG 3 are all investment grade. SG is speculative
Local Government Investment Pools
Not available to the public
Government entities purchase interest in the trust (LGIP)
Prepaid tuition plans
A type of college savings plan
Purchaser buys college tuition credits
- Locks in tuition costs at current levels
- Protects against future cost increases
Not self directed
529 ABLE Plans
Available to individuals who are disabled and are receiving Social Security disability, Medicaid, or private insurance payments
- Maximum contribution is $15,000 per year (no front-
loading)
- Disability payments continue if account value does
exceed $100,000
- Distributions are tax-free if used to pay qualified
expenses
Tax Considerations: Municipal bond interest:
Interest received is exempt from federal tax; however, it may be subject to state and local tax if purchased from a state that is not the bondholder’s resident state
Interest paid on bonds issued by U.S. territories and possessions is triple tax exempt
Bank-Qualified (BQ) bonds
Issued by “qualified small issuers” that issue no more than $10 million per year. BQ bonds allow banks to deduct 80% of the interest cost paid to the depositors on the funds that are used to purchase these bonds.
Who is most suitable to purchase municipal debt?
Investors in higher tax brackets benefit more from the tax-exempt nature of municipal debt; however, municipals are generally unsuitable for investors who are in lower tax brackets or as an investment in retirement accounts
An OID is purchased at $800 with 10 years to maturity. Five years later, the bond is sold for $880. What is the result for tax purposes?
$1,000 par - $700 cost = $300 discount.
- $30 is accreted each year, but not taxable
After 5 years, the basis is $850. The $150 is treated as tax exempt interest income.
If sold at $880, the $30 difference is treated as a capital gain
A bond was issued at par, later purchased for $900 with 10 years left to maturity. Five years later, the bond is sold at $980. What is the result for tax purposes?
$1,000 par - $900 cost = $100 discount
$100 discount / 10 years = $10/YR
After five years, the difference between the cost ($900) and the proceeds ($980) is $80
- $50 of the difference is treated as ordinary income
- $30 is treated as a capital gain
T/F: A VRDO contains a PUT provision
True: A variable rate demand obligation contains a put provision
TIPS
Treasury Inflation-Protection Securities
- Offer a stated coupon with interest paid semi-annually
- Adjust principal for inflation and deflation, based on
CPI
At maturity, you will always get at least par value.
T-STRIPS
Created in the secondary market
B/D or Bank takes a treasury, let’s say note in this case.
- Rather than selling and marketing the 10 year treasury
note, they want to sell each individual payment as a
separate security
Zero-coupon treasury
How are the T-Bills, T-Notes, and T-Bonds issued
By auction:
What are auctions?
- The government sells Treasuries through auctions conducted by the U.S. Treasury
Competitive bids:
- Placed by large financial institutions
- Indicate both quantity and price
Non-Competitive bids: - Placed by the public - Indicate quantity only - Are filled first - Bidder agrees to pay the lowest price (highest yield) of the accepted competitive bids
T-Bills
- Settle on the Thursday following the auction
Agency Securities
Federal Farm Credit Bank (FFCB)
- Provides agricultural loans to farmers
- Subject to federal tax, but exempt from state and local taxes
Mortgage-backed securities:
The most common security issued by government agencies is a mortgage-backed pass-through certificate. Pass-throughs provide excellent credit quality and a slightly higher yield than Treasuries; they are often used to supplement retirement income
Mortgage-backed securities represent an interest in a pool of mortgages:
- Monthly payments consist of interest and principal
- Interest portion is fully taxable (fed, state, local)
- Subject to prepayment risk
Collateralized Mortgage Obligations (CMOs)
Mortgage-backed bonds created by dividing mortgage pools (GNMA, FNMA, and FHLMC) into various bond classes (tranches)
Done primarily to distribute the impact of prepayment risk to different tranches
Interest is generally paid monthly (fully taxable), with principal paid sequentially
Issued in $1,000 denominations
Subject to the act of 1933 & trust indenture act of 1939
Private label CMOs
- Pools include non-U.S. agency mortgage securities
- Subject to the credit risk of the issuer
Planned Amortization Class (PAC Bond) CMO
Provides the most predictable cash flow and maturity
Designed for more risk-adverse investors
Formula to calculate NAV
Calculating NAV per share:
(Total Assets - Total Liabilities) / number of shares outstanding
Calculating the sales charge
Difference between the NAV and POP is the sales charge
Calculating the sales charge %
(POP - NAV) / POP
Industry rules prohibit assessing charges in excess of ____ of the POP
8.5%
12b-1 Fees
Annual fee levied against the fund’s assets
- Allows distribution costs to be borne by the fund,
rather than from front-end charges
Used to finance promotion, advertising, and commissions
- Note: commission in 12b-1 relates to payment to the
brokers, NOT sales charge
Letter of Intent (LOI)
Optional provision that allows investors to qualify for a break-point without initially depositing the entire amount required
- 13 months time period
- May be back dated 90 days
- If backdated, the fund will re-compute the sales
charges on previous purchases
- Non-binding on customer; a portion of shares held in
escrow in case of non-performance
Amount that decreases the longer shares are held
Contingent deferred sales charge
Retroactive reduction in sales charge
Letter of Intent
Sales charge is reduced when a breakpoint is reached
Rights of Accumulation
Redeeming Mutual Fund Shares
A mutual fund investor may redeem (sell) shares and receive the share’s next calculated net asset value (minus any applicable contingent deferred sales charges or redemption fees)
Funds are required to send investors the payment for their shares within seven calendar days of receiving the redemption notice
Redemption Fees
Assessed against investors who redeem their shares after holding them for a short period (often one year or less)
NOT a sales charge; it is returned to the fund’s portfolio
Mutual Fund Distributions
Earnings from a fund are distributed to shareholders and are reported on IRS form 1099-DIV
- Investment Income
- Capital Gains
Both distributions are taxed in the year received whether taken or reinvested
Subchapter M
Relieves a fund’s burden of paying taxes on income as the distributions pass through to the mutual fund shareholders (conduit or pipeline theory)
- To qualify as a Regulated Investment Company, a fund must distribute at least 90% of net investment income to its investors
If it qualifies, the fund is only taxed on the undistributed portion
Burden for paying taxes ultimately falls on shareholders
Net Investment Income Formual
(Dividends + Interest) - (Expenses and Mgmt. Fees)
3 Ways to be taxed on a Mutual Fund
- ) Income Distribution
- ) Capital Gains Distribution
- ) When you sell your shares
Unit Investment Trust Company
Supervised, not managed (no management fee)
Portfolio generally remains fixed for the life of the trust
Ownership usually referred to as shares of beneficial interest (SBI)
A customer purchased an investment company and paid a commission, what type of company would it be?
Closed-End Fund
An open-end would be a sales charge
Exchange-Traded Fund (ETF) vs. Index Fund
- Both consist of a basket of securities which mirror an
index (low expenses)
ETF:
- Shares trade in the secondary market; may be sold short
Index Fund:
- Shares are redeemed by the fund; cannot be sold short
ETF:
- Commission is paid on trade
Index Fund:
- Usually have no sales load
ETF:
- Intra-day pricing
Index Fund:
- Forward priced; once daily
ETF:
- Leveraged and inverse ETFs exist
Index Fund:
- Do not allow leverage
If a client thinks that the S&P is going to decline but doesn’t want to open a margin account, what would be the most suitable recommendation?
Inverse ETF
- Similar to short selling without unlimited risk
Inverse ETF
Designed to perform in a manner that is inverse to the index it is tracking
- Similar to short selling without unlimited risk
Leveraged ETF
Constructed to deliver 2* or 3* the index it is tracking
- May be leveraged inverse ETF
- If the index rises by 1.5%, a 2* long ETF should rise
by approximately 3%
Moving assets from one fund family to another family is referred to as _______ and is a ________ event
Switching, Taxable
A ___________ serves as a pipeline for income distributions to be taxed to the shareholder
Regulated Investment Company
An investment company that can issue preferred stock and bonds is considered a ________
Closed-end fund
Mutual funds make __________ distributions only once per year
Capital gains
Taxation of REITs
No taxation on income if 90% of it is distributed
- Doesn’t pass through losses (unlike limited
partnerships - 20% of distributed income is tax-deductible
Not eligible for dividend exclusion rule
What is the purpose of a DPP?
A Direct Participation Program is a business venture that’s designed to pass through both income and losses to investors
Examples include:
- S Corporations
- Joint Ventures
- General Partnerships
- Limited Partnerships
Advantages of Limited Partnerships
A limited partnership is a business venture that’s designed to pass through both income and losses to investors
- Flow-through of income (no double taxation) and
expenses
^ Income flows through as passive income
^ A portion is taxed as ordinary income (20%
deductible) - Limited Liability
^ Limited partners are only liable for the amount
invested and any loans assumed (i.e., the amount
they have at risk)
Disadvantages of Limited Partnerships
- Illiquid
^ Typically not publicly traded
^ General partner’s approval may be required to sell - Lack of Control
^ Limited partners have limited voting power and no
managerial authority - Effects of Tax Law Changes & Increased Tax
Complexity - Calls to Contribute Additional Funds
Liquidation order for Limited Partnerships
- ) Secured Lender
- ) General Creditor
- ) Limited
- ) General
You are a limited partner, you are asked to contribute additional funds. You do, then the partnership goes bust.
Where do you fall in the order of liquidation?
For any loans that you provided the partnership, you would receive them at the same priority of a general creditor.
- ) Secured Lender
- ) General Creditor
- ) Limited
- ) General
For the funds that you contributed for investment purposes, you would receive them as a Limited partner.
Real Estate Programs
- Raw Land
^ Speculation on land appreciation; no positive cash
flow or depreciation - New Construction
^ Risks of overbuilding, cost overruns, etc. - Existing
^ Existing cash flow, but potential problematic tenant
issues - Low Income (Govt. Assisted)
^ Beneficial potential tax credits; little chance of
appreciation; high maintenance costs
When you invest in real estate, what is the main tax benefit?
Depreciation, you can deduct from your income
When you invest in Oil and Gas programs, what are the main tax benefits?
- ) Depreciation of the equipment
- ) Depletion
- ) In some cases, start up or intangible drilling costs
Advantages & Disadvantages of Equipment Leasing Programs
Advantages:
^ Investors receive consistent income as well as
depreciation tax benefits
Disadvantages:
^ No appreciation of underlying assets
