Chapter 11

Question 1

General Obligation (GO) bonds are backed by the issuer’s ________________________ and their ability to levy _______.

Answer 1

full faith and credit; levy taxes

Question 2

By what types of taxes are state general obligation bonds backed?

Answer 2

Income, sales, or gasoline tax, but also licensing fees and fines.

Question 3

Local general obligation bonds are backed by what type of tax?

Answer 3

Property taxes

Question 4

How is property tax calculated?

Answer 4

Assessed value X millage rate

Question 5

What does 1 mill equal?

Answer 5

.1%

$1.00 per thousand dollars of assessed value (.001 as a decimal)

Question 6

When analyzing GO bonds, what are some important considerations?

Answer 6

Property values, per capita income and debt, population, current debt, tax collection, unfunded pension liabilities

Question 7

Define overlapping debt.

Answer 7

Debt of a municipality that is shared with another political entity (e.g., school district debt)

Question 8

True or False: An increase in unfunded pension liabilities is a negative sign of the municipality’s creditworthiness.

Answer 8

True

Question 9

Revenue bonds are backed by ___________________ generated by ________________________.

Answer 9

specific revenue (user fees) generated by a project or facility

Question 10

Assuming a net revenue pledge bond, what is the first priority according to the flow of funds?

Answer 10

Operating and Maintenance fund

Question 11

Assuming a net revenue pledge bond, what is the second priority according to the flow of funds?

Answer 11

Debt Service

Question 12

To calculate Debt Service Coverage Ratio, the formula used is: (________ - ________) ÷ ___________

Answer 12

(Gross Revenue - O/M Expenses) ÷ Debt Service

Question 13

Debt service represents the total of all ____________ and ____________ payments.

Answer 13

principal and interest payments

Question 14

What is level debt service?

Answer 14

Each year’s debt service payments remaining generally equal.

Question 15

What two sources are used to pay debt service on a double-barreled bond?

Answer 15

revenue and taxes

Question 16

True or False: If revenue falls short, payments on moral obligation bonds only begin with legislative approval.

Answer 16

True

Question 17

A __________________ is a revenue bond backed by one specific tax.

Answer 17

Special tax bond (bonds for highway repair backed by gas tax)

Question 18

A bond backed by a charge to benefiting property owners is called a __________________________.

Answer 18

special assessment bond (water/sewer)

Question 19

What bond would be issued to build a facility for a private company?

Answer 19

Industrial Development Revenue (IDR)

Question 20

True or False: The credit rating of an IDR is based on the credit of the municipality.

Answer 20

False. The rating is based on the corporation making the lease payments.

Question 21

What types of municipal bonds are most likely subject to the Alternative Minimum Tax?

Answer 21

Private Activity Bonds

Question 22

Bonds subject to the AMT will trade with a _________ yield.

Answer 22

higher

Question 23

What is a Bond Anticipation Note (BAN)?

Answer 23

Municipal note issued for a capital project that will eventually be paid from the proceeds of a long-term bond

Question 24

What is a Revenue Anticipation Note (RAN)?

Answer 24

Municipal note that will eventually be paid from future federal or state subsidies

Question 25

What is a Tax Anticipation Note (TAN)?

Answer 25

Municipal note issued in anticipation of future real estate taxes

Question 26

What is a Grant Anticipation Note (GAN)?

Answer 26

Municipal note issued in anticipation of receiving government funding in the form of a grant

Question 27

What is a Construction Loan Note (CLN)?

Answer 27

Municipal note issued to provide funds for construction of housing projects to be repaid by permanent financing

Question 28

What are some examples of tax-free money-market instruments?

Answer 28

Municipal notes and tax-exempt commercial paper

Question 29

The maximum maturity of commercial paper is ____ days.

Answer 29

270

Question 30

How often will VRDOs adjust their interest rate?

Answer 30

At specified intervals such as daily, weekly, or monthly. VRDOs may allow owners to put (sell) back to the issuer.

Question 31

MIG stands for ___________________________.

Answer 31

Moody's Investment Grade

Question 32

Standard & Poor’s three ratings for municipal notes are ______, ______, ______.

Answer 32

SP-1, SP-2, SP-3

Question 33

Municipal bond interest is exempt from __________ tax.

Answer 33

Federal

Question 34

What condition must exist for a municipal bond’s interest to be exempt at the state and local level?

Answer 34

bond bought from state they live in

Question 35

Who may issue bonds that offer interest that is triple tax-exempt?

Answer 35

commonwealths, territories and possessions

Question 36

The formula for taxable equivalent yield is: __________ ÷ (________ - ________)

Answer 36

Tax-Free Yield ÷ (100% - Tax Bracket %)

Question 37

The formula for net (after-tax) yield is: __________ x (________- ________)

Answer 37

The formula for net (after-tax) yield is: Taxable Yield x (100% - Tax Bracket %)

Question 38

Accrued interest on municipal bonds is calculated using ____ days in the month and _____ days in the year.

Answer 38

30 days/month, 360 days/year

Question 39

What is the tax consequence if a municipal bond is purchased at a secondary market discount and held to maturity?

Answer 39

gain is taxed as ordinary income

Question 40

What is a municipal OID?

Answer 40

Original Issue Discount bond

Question 41

What is the tax consequence if a municipal Original Issue Discount (OID) bond is held to maturity?

Answer 41

None

Question 42

The process of adjusting the basis of an Original Issue Discount bond up to par over its life is called ____________.

Answer 42

accretion

Question 43

What is the IRS method for accreting the basis of a bond?

Answer 43

Constant yield or constant interest method

Question 44

What is the tax consequence if a municipal Original Issue Discount (OID) bond is sold prior to maturity?

Answer 44

A capital gain or loss determined by the difference between the adjusted basis and the proceeds on the sale

Question 45

An OID is sold prior to maturity. Is the capital gain (or loss) based on the original cost basis or accreted value?

Answer 45

Accreted value

Question 46

The process of adjusting the basis of a premium bond down to par over its life is called _______________.

Answer 46

amortization

Question 47

How is the phantom interest on an OID treated for tax purposes?

Answer 47

tax exempt

Question 48

What is the tax consequence if a municipal bond is purchased at a premium and held to maturity?

Answer 48

amortized down to par, so no gain/loss. No tax consequences

Question 49

What is the tax consequence if a municipal bond is purchased at a premium and sold prior to maturity?

Answer 49

A capital gain or loss determined by the difference between the adjusted basis and the proceeds of the sale

Question 50

How is interest on municipal bonds treated for tax purposes?

Answer 50

Federally tax-exempt, but may be subject to state and local tax

Question 51

A decision of the ___________________ created the tax exemptions for government and municipal bonds.

Answer 51

U.S. Supreme Court

Question 52

A muni. bond is bought at a secondary market discount and sold for a gain before maturity. What is the tax consequence?

Answer 52

The gain is taxable as ordinary income up to the accreted value, and a capital gain for any amount above that.

Question 53

$9 million gross revenue, $3 million oper./maint. expenses, and $2 million debt service. Debt service coverage ratio?

Answer 53

3:1 (gross revenue-operating)/debt service (9-3)/2

Question 54

Mack, in the 35% tax bracket, is earning 5.4% on a tax-free municipal bond. What is his taxable equivalent yield?

Answer 54

The formula is: Tax-Free Yield ÷ (100% - Tax Bracket %). 5.4% ÷ 65% = 8.3%

Question 55

In what covenant does the issuer pledge to keep the project in good working order?

Answer 55

Maintenance and Operation Covenant

Question 56

True or False: The Flow of Funds covenant on a revenue bond describes the priority for distributing project revenue.

Answer 56

True

Question 57

What is the net yield for an investor in the 28% tax bracket who owns an 8.5% corporate bond?

Answer 57

The formula is: Taxable Yield x (100% - Tax Bracket %). 8.5 x 72% = 6.12%.

Question 58

What are Auction Rate Securities (ARS)?

Answer 58

Long-term bonds (municipal or corporate) with a variable interest rate set periodically through a Dutch Auction

Question 59

How does the Dutch Auction set the interest rate on Auction Rate Securities?

Answer 59

It sets the lowest interest rate at which all the securities being offered will clear the market (net clearing rate).

Question 60

True or False: The interest rate reset periods on Auction Rate Securities range from 7, to 28, or 35 days.

Answer 60

True

Question 61

Moody’s rates municipal notes using ______, ______, ______, ______.

Answer 61

MIG1, MIG2, MIG3, SG.