Chapter 3- Municipal Securities 30-40 questions

Question 1

Municipal Bonds

Answer 1

Securities issued either by state or local government or by US teritiories, authorities and special districts

Purpose of public works and construction projects

Second in safety of principal only to Us gov

Generally pay lower interest due to tax adv.

Should take into account when evaluating against a corporation

Question 2

Municipal bond taxation

Answer 2

Interest is Not generally taxed by the federal government (origin from Doctrine of Reciprocal Immunity which states level of gov can tax only interest of own issues)

US territories are not taxed at any level

Capital gains are still taxed, may not be subject to tax if municipal is in state

Buying low and selling high results in capital gains

If living in a different state then the bond may be taxed

Question 3

Issues of Municipals

Answer 3

Territorial possessions of the US

State Government

Legally constituted tax authorities (counties, agencies etc)

Question 4

Maturity Structures of Municipals

Answer 4

Maturity ranges from less than a year to more than 30

3 different types of maturity:
1. Term Maturity- All matures at single date, quoted by price, called dollar bond

2. Serial Maturity- Mature on different dates to a predetermined schedule. Quoted based on yield to maturity. Most common
3. Balloon Maturity- Pay partial amount, but largest portion is paid off at maturity. Type of serial maturity

Question 5

General Obligation Bonds

Answer 5

Municipal bonds issued for capital improvements that benefit entire community

Paid by taxes collected by municipal issuer such as property tax (ad valorem), license fees

Known as full faith and credit issues

Municipalities may have debt limits to protect taxpayers

Voter approval is required if wanting to go over limit

Property taxes are usually limited to a certain percentage and expressed in mills

One Mill equals $1 per 1000 or .001

Limited tax GO- secured by specific tax, more risk associated

Overlapping debt (coterminous debt)- several different municipal authorities taxing same person. Only occurs with property tax

Double Barreled Bonds- Revenue bond that also has the backing of taxation

Question 6

Revenue Bonds

Answer 6

Used to finance municipal facility that generates sufficient income

Additional Bonds test may be issued before a subsequent issue with an equal Lien can be completed

Feasibility study on economic feasibility and need is issued before project is taken on

Interest and principal paid from: Utilities, housing, transportation, education, health, industrial and sports

Not backed by taxes

A trust indenture (referred to on face) protects bondholders by making sure the facility is in compliance… usually issued but not required

Question 7

Common bond covenants

Answer 7

Rate covenant- promise to maintain rates sufficient to pay expenses and debt services

Maintenance- maintain equip and facility

Insurance covenant

Additional Bonds test- all debt after is subordinated unless needed for completion

Sinking fund

Catastrophe clause

Flow of funds/ priority of disbursing funds

Question 8

Industrial Development Revenue Bonds

Answer 8

Issued to construct facilities or purchase equipment that is later leased to a corporation

Carries corporation debt rating

Payment of the issue is ultimately the responsibility of the corporation

Tax Reform Act of 1986 causes most of these to be taxed under the alternative minimum tax but not to those not filling under ATM

Question 9

Lease rental bonds

Answer 9

Issued to finance office construction for itself or its state or its community

Example: building a school which is paid back by tuition

Basically a lease back agreement (make to lease)

Question 10

Certificate of Participation

Answer 10

Form of lease revenue bond that permits investors to participate in revenue from lease, installment or loan payments

On specific equipment or land of municipal

Certificate holders could technically foreclose on the asset

Question 11

Special tax bonds

Answer 11

Secured by one or more designated tax outside of property (ad valorem) tax

Does not have to be directly related to projects purpose

Question 12

Special Assessment Bonds

Answer 12

Issued to finance the construction of public improvements such as streets sidewalks sewers

Property tax only on those benefiting

Question 13

New housing authority bond

Sometimes called Public Housing Authority bonds or Section 8 bonds

Answer 13

Funds used to improve low income housing backed by US gov

Most secure of all municipal bonds

Backed by rental income of the houses

Not a double barreled because it’s second revenue source is US gov

Question 14

Moral Obligation Bonds

Answer 14

State, local or agency issued bond

State legislature can appropriate funds to make payments, but not established by law

Revenue Bonds only

Question 15

Issuer Default

Answer 15

Bondholders have right to sue if a GO bond goes into default

Moral Obligation Bonds would have to receive a legislative apportionment

Question 16

Municipal Anticipation Notes

Answer 16

Issued for municipality that expects other revenue soon

Ones that aren’t exactly how they seem:
1. Bond anticipation notes- interim financing that will turn into long term funding

2. Variable rate demand notes- fluctuating interest rate with a put options

Question 17

Variable Rate Municipals

Answer 17

Offers interest tied to another specified interest rate

Price remains relatively stable throughout life

Usually reset to Market every 6 months

Question 18

Auction Rate Securities

Answer 18

Tied to short term interest rates

Long term maturities of 20 to 30 years

Rate is determined by a Dutch auction at short term intervals at 7, 28, or 35 days

Typically issued by hospitals, utilities, nonprofit housing, university

Failed auctions are hazard as no demand may be found and may effect rating

Question 19

State and Local Government Securities Series

Answer 19

US treasury securities directly issued to municipal issuers only in connection with pre refunding

Immediately invests in state or local gov securities

Directly issued by US Government

Question 20

Build America Bonds

Answer 20

Taxable obligations but generally tax credits are given in lieu

Assist in reducing costs to issuing municipalities and to stimulate economy

Two types:
1. Tax Credit BABs- fed income tax credit equal to 35% of interest paid on bond during year, may be carried forward

2. Direct Payment BABs- Provide municipal issuer with payment of 35% of interest

Currently not instated

Question 21

Bond Contract

Answer 21

Collection of legal documents that includes a bond resolution, applicable law, and other legal docs pertaining to the issue or issuer

Question 22

Bond Resolution

Answer 22

Municipality authorizes issue and sale of securities through this

Most include the indenture to increase marketability

Not required by law

Serves as a contract between issuer and trustee

Flow of funds statement is normally included and establishes the priority of payments from a facilities revenues

Question 23

Official statement

Answer 23

Prospectus for a municipal

Includes a feasibility statement and any material information needed to be known

Must be given to investor before settlement date

May follow a preliminary official statement

Question 24

Bond Counsel

Answer 24

An attorney specializing in tax exempt bonds

Either issues their legal opinion as a:

Qualified opinion- may be a legal uncertainty
Or
Unqualified opinion- unconditional

Some smaller issuers may not obtain a legal opinion and are marked ex legal

Ex legal mark allows bond to be issued in good delivery

Legal opinion is in regards to both the legality and tax exempt status of the issue

Question 25

Negotiated underwriting

Answer 25

Investment banker underwrites and helps establish interest rate and offering price Can be either a public offering or private placement

Question 26

Competitive Bidding

Answer 26

Municipality posts an invitation to bid Investment bankers respond requesting info and then bid, with lowest net interest cost winning An official notice of sale is usually published in The Bond Buyer and local newspapers Official notice of sale includes all information needed to make a bid including the amount of good faith deposit required to submit the bid Bonds rating and underwriter name are not included because they haven't been determined All bonds are issued in fully registered or Book entry form

Question 27

The Bond Buyer

Answer 27

Published every business day and offers info on primary bond market Shows 30 day visible supply (total dollar volume in next 30 days expected) Small supply means interest rates likely to fall Placement/acceptance ratio indexes- percentage of total dollar value of sold over offered for sale Also includes 40 bond index- daily price index, 20yr mature, includes 40 GO and Revenue bonds 20 bond- weekly, 20yr GO, A of better 11 bond- 11 of 20 20bond, AA or better revdex 25- 25 rev bonds, 30yr mature, A or better Yields for Revdex higher due to more risk in rev bonds

Question 28

Thomson Muni Market Monitor

Answer 28

Offers current news items pertaining to secondary municipal market and current offerings Secondary market

Question 29

Real Time Transaction Reporting System

Answer 29

Provides information generated from the National Securities Clearing Corp to the public within 15 minutes

Question 30

New Issue Worksheet

Answer 30

Presented by the Bond Buyer Shows all information used in the official notice of sale Schedule of year by year maturities Bond years are the number of 1k bonds being sold by number of years outstanding 1000 bonds 2 yrs maturity= 20,000 bond years

Question 31

Bond Years

Answer 31

Years to Maturity x # of bonds Used to calculate the average life of an issue Total bond years / total bonds

Question 32

Syndicate letter

Answer 32

Sent out to each underwriter two weeks before issue is awarded to be signed ``` Includes: level of participation Priority order of allocation Duration of syndicate Appointment of managers as agent Fees and breakdown of spread Other obligations ``` Not legally binding till submission of bid

Question 33

Syndicate account types

Answer 33

Establishes the liability of each underwriter 2 types Western account- Each underwriter is responsible for their own allocation Eastern Account- Undivided, each underwriter is allocated a portion of the issue. Given a proportionate share of what is written West is divided, east is united If issues not sold, west is responsible for their share, east everyone takes their share

Question 34

Writing the scale

Answer 34

Process by which a syndicate will establish the reoffering yield (price) Must determine what yield is necessary to sell the bond and then adding the premium to get to the bid

Question 35

Firm commitment

Answer 35

All competitive bids are submitted as firm commitments No profit guaranteed Will buy the whole issue no matter what

Question 36

Two possible reasons to award an issue

Answer 36

Lowest Net Interest Cost or the lowest True interest cost NIC- combines proceeds with total coupon interest TIC- combines same principals but also factors in TVM A deposit is usually put down during the bidding process, around 1-2% of par

Question 37

Syndicate Account

Answer 37

Developed when the issue is awarded Syndicate manager handles the books All proceeds from the sale and expenses siphon out of the account 30 calendar day account

Question 38

Spread

Answer 38

Difference between the bid and ask In the case of a syndicate, the purchasing price and the reoffering price Production refers to the total dollars earned from a municipal issue

Question 39

Point

Answer 39

Management fees are referred to in points 1 point is equal to $10

Question 40

Total Takedown

Answer 40

Portion of the spread remaining after subtracting management fee Syndicate members can either realize their full takedown or give a partial amount to other sellers The concession is the amount that a seller will make by selling the bond

Question 41

Reallowance

Answer 41

Usually a syndicate will notify other buyers in the Bond Buyer Typically, they are offered at a smaller discount typicall half the concession price

Question 42

Size of each portion of the spread | Small to large

Answer 42

Managers fee Additional takedown Concession Syndicate member would receive total spread of it is the manager and sells the bond

Question 43

Order priority for Municipals

Answer 43

Must be defined according to the Municipal Security Board Timeline Established: 1. Order period- usually an hour the day after the awarded bid 2. Of over-subscribed, order priority is followed. Explained on next card

Question 44

Order types in order from top to bottom in priority

Answer 44

1. Presale order- entered before a syndicate wins the bid. Takedown is split among participants in the order 2. Group net order- Placed after the bid is awarded, split between participants 3. Designated orders- institutional order, allocates takedown to certain members 4. Member and member related orders Highest priority given to orders that benefit most members Orders are summarized and sent to each member by syndicate manager Pro Golfers Don't Miss

Question 45

Municipal bond delivery

Answer 45

On a when-issued basis meaning, the bonds are authorized but not yet issued Managing underwriter must register with a clearing agency, who is given notice of the coupon and settlement date Syndicate then gives notice to buyers Underwriters then send out final confirmations with the purchase price and settlement date

Question 46

Difference between dated date and settlement date

Answer 46

Dated date is the day in which interest begins to accrue. Investor must pay interest from dated date up to the settlement date

Question 47

Criteria used to evaluate GOs or General Obligation Bonds

Answer 47

General Wealth of the community (because GOs are backed by tax revenues) Quantitative (statistics) and Qualitative (community opinion) analysis Debt limit and the city charter as they may restrict lending abilities Municipality income from taxes and fines Ad Valorem (Property) taxes- States/counties have right to seize land if tax not paid The Official statement and the underlying financial statements- look for possible future cash needs, and rating decreases Also the debt statement, which sheds light on the debt structure (explained next)

Question 48

Debt Structure

Answer 48

Total debt - self supporting debt(revenue bs) - sinking fund accumulations = net direct debt or GOs and short term notes + Overlapping Debt (share of county, school, park, sanitary debts) = net overall debt If net, then no self support or sinking fund

Question 49

Criteria used to evaluate revenue Bonds

Answer 49

Based on facilities potential to generate money to cover operating expenses, principal and interest expenses ``` Should consider the following: Economic Justification Competing facilities Sources of revenue Call provisions (the higher the premium the better) Flow of funds Debt service coverage ```

Question 50

Net revenue pledge (typical flow of funds)

Answer 50

1. Operations and Maintenance 2. Debt service Account- Used to pay in year interest and principal maturing 3. Debt service reserve fund- Can hold one year debt service 4. Reserve maintenance fund- supplements general maintenance 5. Renewal and replacement fund- reserve fund for major renewal or equipment replacements 6. Surplus (sinking) fund If operations and maintenance is not first, debt repayment is (gross revenue pledge)

Question 51

Municipal Debt Ratios (more important to understand than calculate)

Answer 51

1. Net debt to assessed value: debt per assessed property value, alternate uses estimated (preferred). 5% is reasonable 2. Taxes per capita: tax income of city/person 3. Debt per capita: city debt per person 4. Debt trend: whether ratios are rising or falling 5. Collection Ratio: Taxes collected / assessed 6. Coverage Ratio: how many times revenue will cover debt service, 2:1 is acceptable

Question 52

Outside factors effecting both Revenue and GO bonds

Answer 52

Interest Rate comparisons amongst similar bonds (smaller market due to uniqueness) Municipal Bond Insurance- typically lowers interest yield but offers more safety Bond Rating- S&P or Moody rating Moody- MIG 1-4 is good, SG is speculative S&P- SP-1 through 3 Fitch F-1-3

Question 53

Quotations of Municipal bonds

Answer 53

Sold in the OTC market Interest or solicitation by a municipal dealer would be considered a quotation request Basis quote- Priced on a yield to maturity basis called a basis quote Some revenue bonds are quoted on a % of par dollar basis and are called dollar bonds Ex. 104 means 104% of par

Question 54

Bona Fide Quotation

Answer 54

To be considered bona fide, a dealer must be prepared to sell at the price The quote must reflect the dealers best judgement and have a reasonable relationship to the fair market value May reflect firm inventory/expectation of market direction Quotations are subject to prior sale or change in price

Question 55

Four types of quotations

Answer 55

1. Bona Fide 2. Workable indication- bid price at which a dealer will purchase securities from another dealer. Able to be revised. 3. Nominal (subject) quotation- Indicate a dealers estimate of a securities market value 4. Out firm with recall quote- Good for an hour with a 5 minute recall period (if a firm receives an offer after another one, they can give a 5 minute period where the original buyer has to commit)

Question 56

Secondary market joint or trading account

Answer 56

Formed by a group of investment bankers to purchase large blacks of bonds from institutions and resell them Joint account can only issue one quote when reselling bonds 30 calendar days to settle

Question 57

Report of sales of Municipals

Answer 57

MSRB rules prohibit false reports of trades Municipal dealers report trades with other dealers to the National Securities Clearing Corp. Must include the names and accrued interest

Question 58

Round lot for Municipals

Answer 58

100,000 in face

Question 59

Broker's Broker

Answer 59

Some only trade with banks and other municipal brokers Do not disclose ID of customers Do not maintain an inventory of bonds

Question 60

Reciprocal dealings (antireciprocal rule)

Answer 60

Cannot solicit trades in Municipals from an investment company in return for sales by dealer of share or units in the investment company

Question 61

MSRB Rules on Municipal trading

Answer 61

Suitability of client must be tested before a recommendation is made Should not put Municipals in an IRA or 401k Best suited for those who want income Can open the account but not make recommendations if info not available Cannot guarantee against loss, share in profits, or misuse funds If a control relationship (the dealer has control in the issuer) additional disclosure is needed in the form of writing to the client usually on the confirmation.

Question 62

Markups vs Commission

Answer 62

Commissions- When a dealer acts as an agent by buying trades for a customer it charges commission Markup- When a dealer acts as a principal (buying and selling for its own inventory), it charges a markup when selling to customers and a mark down when buying from customers

Question 63

Principal Transactions

Answer 63

Executed at a net price including the markup markdown ``` Factors in the trade include: Best judgement of FMV Expenses of transaction Dealer is entitled to a mark up or down (not disclosed) Total dollar amount Value of exchanged securities ``` The markup or markdown is not disclosed on the confirmation

Question 64

Agency Transactions

Answer 64

Executed for a commission Trading outside of the dealers holdings ``` Take into consideration: Security's available Expense of execution Value of services provided Amount of other compensation received ``` Commissions are disclosed to the customer

Question 65

Confirmation disclosures

Answer 65

Must describe security, list fade date, settlement date, accrued interest, firm info, and whether acting as agent or principal MSRB rule: When disclosing yield on a callable bond, must state the lower of YTM or YTC. For discount bonds it is YTM, premium bonds it's YTC If there are a number of call dates on premium bonds, then use near term in whole call Variable Rate Bonds, bonds in default, and bonds sold at par have no yield specified

Question 66

Required info on confirmations

Answer 66

In agency Transactions, the other party and the amount of commission must be disclosed The dated date of it affects interest calculation Whether the securities are fully registered, registered to principal only, book entry form or in bearer form Whether the security is called or pre refunded Any special qualification or factor that might affect payment Whether bond interest is taxable

Question 67

Broker/dealer acting as an Financial Advisers to municipal securities issuers

Answer 67

Relationship exists when a muni dealer provides advisory or consulting services to an issuer with respect a new issue Conflict of interest would arise if FA acts as both underwriter and FA and is banned by MSRB Can still help prepare official statement, and buy from the underwriting for customers (customers must be informed) Cannot use confidential info to solicit purchases or sales

Question 68

Tax Reform Act of 1986

Answer 68

Restricted fed income tax exemption for municipal bonds to public purpose bonds If more than 10% of proceeds go to private parties, it's considered a private activity bond

Question 69

Calculation for determining tax benefits of a municipal

Answer 69

Tax free yield/ (100%-tax rate) = yield required To reverse Yield of other X (100%-TR) = yield in tax free Use the Yield to Maturity Expenses related to the purchasing and holding of the Municipals are non deductible Exception *- banks purchasing certain issues of GO bonds can deduct 80% of interest

Question 70

Property taxes

Answer 70

Property taxes are not issued by states and therefore cannot be conterminous

Question 71

To be double barreled, a bond must be backed by

Answer 71

2 different municipal revenue source

Question 72

Dated date

Answer 72

No longer used after first interest payment is made

Question 73

Contra broker

Answer 73

Not necessary as long as it is stated that the name is available upon request

Question 74

Schools

Answer 74

Financed by GO bonds in general Hospitals, airports and golf courses are usually financed by revenue Bonds

Question 75

Moody's investment Grade Rating are applied to

Answer 75

Municipal notes, not municipal bonds

Question 76

Bond Placement Ratio

Answer 76

$ value of new issues sold divided by dollar value of the new issues offered

Question 77

Callable municipal bonds

Answer 77

Call premiums tend to decrease over time And Call prices are stated as a percentage of the principal amount to be called