Chapter 4 - Debt Instruments

Question 1

• this term is referred to as a debt instrument
• it creates a liability for the issuer and is issued by corporations, municipalities, and the US government
• the face amount or par value is $1,000
• this term has a stated interest (%), which expresses the income the investor will receive
• this type of investment has greater safety but limited growth potential and is more appropriate for older conservative investors

Answer 1

Bond

Question 2

• higher risk bonds tend to provide higher yields
• lower risk bonds tend to provide lower yields
• this term is the relationship between an investment’s risk and its yield

– this relationship dictates that the higher an investment’s risk, the higher its potential reward (and vice versa)

Answer 2

Risk/Reward Ratio

Question 3

• this type of risk is also referred to as Business or Default Risk
• this term is the risk that an issuer may become unable to meet interest or principal payments on its bonds
• factors that affect this risk are competitive pressure, market share, profit margin, and competence of management
• this risk is managed with a long term focus
• this risk is lowest with US government debt and highest with corporate debt

Answer 3

Credit Risk

Question 4

• this type of risk pertains to the threat of suffering a loss due to a change in the interest rate
• all fixed income securities are subject to this type of risk
• longer maturities are at greater risk than shorter maturities
• lower stated rates for bonds are more volatile than higher

Answer 4

Interest Rate Risk

Question 5

• this type of risk is also referred to as Purchasing Power Risk or Constant Dollar Risk
• this term is the risk that an investment’s value is negatively affected by inflation
• all fixed income securities are subject to this type of risk

Answer 5

Inflation Risk

Question 6

• this is the risk that in a falling interest rate environment, bond proceeds must be reinvested at lower rates

– this would in turn reduce the investor’s yield

• an investor who wishes to eliminate this type of risk over the life of a bond will purchase a zero-coupon bond

Answer 6

Reinvestment Risk

Question 7

• this is the risk that a callable bond will be redeemed by the issuer before maturity
• this typically happens when interest rates have fallen
• the investor accepts this risk in return for higher yields

Answer 7

Call Risk

Question 8

• this is the risk that changes in the US dollar/foreign currency exchange rate will negatively impact the security

– for example, a Eurobond is a bond that is issued outside of the US and is denominated and pays interest in a foreign currency. If that currency falls against the dollar, the value of the interest payments and principal to a US investor will decline as well

Answer 8

Currency Risk

Question 9

• this is the risk that an asset cannot be sold quickly, or that selling quickly will result in a substantial loss
• this type of risk increases as the total quantity of a security decreases
• actively traded securities generally have less of this type of risk

Answer 9

Liquidity Risk

Question 10

• this is the risk of being unable to buy or sell a security, thus sustaining a loss
• this type of risk is not concerned with the price of the security, only the ability to buy or sell

Answer 10

Marketability Risk

Question 11

• also referred to as Legislative Risk or Political Risk
• this is the risk that changes in law will negatively impact the value of a security

Answer 11

Regulatory Risk

Question 12

• also called Dollar Bonds
• in this type of bond issue, all of the bonds are issued at once and all mature at once
• these bonds are priced in points as a percentage of par value

– each point equals $10 (i.e. quote of 98 = $980)

Answer 12

Term Bond

Question 13

• this type of bond is quoted as either a percentage yield or in basis points

– one basis point (BP) = 1% (i.e. a 6.10% yield = 610 basis points)

• in this type of bond issue, all of the bonds are issued at once. However, they mature in increments over several years

Answer 13

Serial Bond

Question 14

• this term is also known as the Nominal Yield or Coupon Rate
• this term is the rate which the issuing corporation has contracted to pay interest through the life of the bond

– this rate never changes; the issuer will pay this term until the bond matures and is extinguished

Answer 14

Stated Rate

Question 15

• this term is calculated by dividing the annual interest by the current market value of the security rather than the face amount (par value) of the bond

– an increase in the bond’s current market value results in a decrease in this term

• this term represents the return on investment by relating the annual coupon rate to the current price of the bond

Answer 15

Current Yield

Question 16

• this term, expressed as a percentage, is the total return that would be realized on a bond or other fixed income security if the bond were held until the maturity date
• this term may be greater than the Current Yield if the bond is selling at a discount, or less if the bond is selling at a premium
• this term considers nominal yield realized during the holding period as well as the difference between the purchase price and par value received at maturity
• this term is a rate of return measuring the total performance of a bond from the time of purchase until maturity

Answer 16

Yield to Maturity

Question 17

• this term evaluates the performance of a callable bond from the purchase date to the call date
• it is the yield realized on a callable bond if the bond was redeemed by the issuer on the next available call date
• this term considers the nominal yield realized during the holding period as well as the difference between the purchase price and the call price received at the call date

Answer 17

Yield to Call

Question 18

• this term is the measure of the current net market yields on a mutual fund’s investment portfolio
• this term is based on the net investment income for the 30-day period ending on the last day of the previous month divided by the highest offering price on that last day

Answer 18

Standardized (SEC) Yield

Question 19

• bond interest is paid in arrears, meaning that an investor purchases and holds a new bond for 6 months before receiving the first semiannual interest payment
• interest is paid for the 6-month period before the interest payment date

– this means that an investor must hold the bond for the entire 6-month accrual period to earn the entire semiannual interest payment

• this term is calculated with two different sets of assumptions

– corporate, municipal, and government agency bonds assume every month has 30 days and every year has 360 days. Regular way of settlement is T + 2

– government notes and bonds, however, use the actual numbers of days in the month and year. Regular way of settlement is T + 1 or the next business day following the trade date

• when calculating this term, it is important to remember that the accrual period is from the last interest payment date up to, but not including the settlement date (i.e. do not include the settlement date but include the trade date when calculating)

Answer 19

Accrued Interest

Question 20

• can be secured or unsecured

– if secured, the issuer of the bonds has transferred title to specific assets to the custody of the trustee meaning that the bond is backed by the pledge of collateral, a mortgage, or other lien

– secured bonds have priority in the event of liquidation over all other claimants except the IRS and employees’ wages

Answer 20

Corporate Bond

Question 21

• this term is the most common type of Secured Bonds
• this type of bond is collateralized by a lien or mortgage against real property
• this type of bond can be classified as “first” or “second”, with first having senior position with respect to a claim on assets in the event of a foreclosure or liquidation
• this type of bond can be issued as either open-end or closed-end

Answer 21

Mortgage Bond

Question 22

• this type of bond classification allows the corporation to issue subsequent bonds secured by the same property at a later time

Answer 22

Open-End Bond

Question 23

• this classification of bonds specifies the maximum indebtedness the corporation can issue against the same lien

– this classification of bonds offers the investor greater protection

Answer 23

Closed-End Bond

Question 24

• this term will specify if the secured bonds are open-end or closed-end
• this term is a contract between the issuer and the trustee, who acts on behalf of the bondholders
• the open- or closed-end clause in this term pertains to the status of existing bondholders should additional bonds be issued

Answer 24

Bond Trust Indenture

Question 25

• this type of Bond Indenture states that new bonds have equal status with the original bonds
• in other words, the new bonds have equal claim, or parity of title, to the collateral
• this potentially reduces the safety of the original bonds, since more bonds have claim to the same collateral
• typically, a requirement must be met before additional bonds may be issued (i.e. 95% occupancy rate before additional bonds may be issued)

Answer 25

Open-End Bond Indenture

Question 26

• this type of Bond Indenture requires that if additional bonds are issued, they must be subordinate in collateral claim status to the original bonds

Answer 26

Closed-End Bond Indenture

Question 27

• this term is usually issued by railroads and airlines, and are secured by railroad cars and airplanes
• these have historically proven to be secure investments because the bonds are retired at a faster rate than the equipment is depreciated
• it is important to understand that it is the issuer who owns and operates the equipment (i.e. American Airlines might issue this term and use airplanes as collateral)

Answer 27

Equipment Trust Certificate

Question 28

• this term is back by the securities of a different issuer (i.e. Dell owns several shares of Intel stock and uses the Intel stock to secure the bond/this term)

– if Dell defaulted on this, the Intel stock would be sold to satisfy the bondholders’ claim

Answer 28

Collateral Trust Certificate

Question 29

• also referred to as Unsecured Corporate Bonds
• this term is the most common type of Unsecured Debt and is backed only by the full faith and credit of the issuer

– there is no specific collateral backing

• while this term carries more risk than a Secured Bond, it generally pays a higher coupon rate than a Secured Bond from the same issuer

– this term’s claim is subordinate to that of Secured Bond’s in the event of liquidation

• this term can come in several forms with a variety of features

Answer 29

Debenture

Question 30

• this type of Debenture is backed by the faith and credit of the issuer
• this term has been cosigned by another entity (usually a parent or affiliate)

– this means that if the issuer becomes insolvent, the affiliate will resume interest and principal maintenance on the bond

• this term is more attractive and marketable than a normal Debenture but does have the trade-off of a lower Nominal Rate

Answer 30

Guaranteed Bond

Question 31

• this type of Debenture is convertible into the common stock of the issuer at the bondholder’s discretion
• conversion is optional, and the investor may choose to never convert
• this term’s price is affected by the price of the stock because it can be converted into common stock
• this term has a Conversion Ratio that never changes

– [# of Shares at Conversion = (Par Value / Conversion Price)]

• this term and its respective common stock are at parity when the bond and stock prices are equal (i.e. $1,000 par value = $1,000 value of stocks)

Answer 31

Convertible Bond

Question 32

• also referred to as a Step Coupon Bond
• this Debenture has an initial Nominal Rate which later increases to a pre-specified higher rate
• this term is typically a Corporate Bond, however, certain government agencies use them

Answer 32

Step-Up Bond

Question 33

• this Debenture (also referred to as an Adjustment Bond) is the product of a debt renegotiation or a bankruptcy proceeding

– when a corporate can no longer honor the terms of a bond issue, it will often renegotiate the terms of the issue with the bondholders

• this term no longer pays semiannual interest and won’t unless the issuer returns to a profitable position

– this means that this term trades without Accrued Interest

• this type of Debenture is very speculative and may not return 100% principal at maturity

Answer 33

Income Bond

Question 34

• also referred to as US government securities or Treasury Securities
• this term is a very safe investment because it is backed by the full faith and credit of the US government
• this term is also highly liquid
• interest on this term is subject to federal taxation only
• capital gains are fully taxable

Answer 34

Treasuries

Question 35

• this term is a classification of debt instrument that is issued by the US Treasury
• this term does not trade from investor to investor in the secondary market
• must be redeemed by the Treasury through banks
• these securities include Series EE, Series HH, and Series II savings bonds
• issued in book-entry form

Answer 35

Non-Marketable Securities

Question 36

• this term is a classification of debt instruments issued by the US Treasury
• this term (i.e. T-bill, T-note, T-bond) can be traded for value in the Secondary Market
• issued in book-entry form
• the three main forms of this term are T-bills, T-notes, and T-bonds

Answer 36

Marketable Securities

Question 37

• also referred to as an Original Issue Discount Instrument (OIDs)
• this term does not have a Stated Interest Rate and does not pay semiannual interest
• this term is bought at a discount from par and then matures at par

– the difference between purchase price and par value is the interest earned by the investor

• this term is quoted on a Discount Yield Basis, which means that the quote is a discount from par value
• this term’s published bid price appears larger than the published ask price
• issued in denominations of $1,000 (increments of $1,000 too) with maturities of 4 weeks (1 month), 13 weeks, 26 weeks, and 52 weeks (1 year)

– this term is issued in book entry form and sold through auctions

Answer 37

Treasury Bills

Question 38

• this term is issued with maturities of 2 years, 3 years, 5 years, and 10 years and in denominations of $1,000

– issued in book-entry form

• this term has a Stated Interest Rate, pays semiannual interest payments, and is known as an Interest-Bearing Security
• quoted in points as a percentage of par (broken down to 1/32 increments)

Answer 38

Treasury Notes

Question 39

• this term has a maturity term greater than 10 years at issuance and pays a fixed interest rate
• issued in book-entry form and in denominations beginning at $1,000
• pays semiannual interest payments to their owners and are known as interest-bearing securities
• quoted in percentages of par (1/32 increments)

Answer 39

Treasury Bonds

Question 40

• this Treasury-issued security’s principal is adjusted for inflation using the CPI

– the adjustment is taxed as ordinary income in the year the cost basis is adjusted

• the Stated Interest rate is constant

– semiannual interest payments fluctuate based on the principal

• this term is issued in 5-, 10-, and 30-year maturities

Answer 40

Treasury Inflation Protected Security (TIPS)

Question 41

• this term is a Treasury-issued zero coupon bond
• issued at a steep discount directly from the US Treasury
• this term accretes in value, meaning that it gains in value every year

– this gain is considered interest income

• owning this term creates Phantom Income for the investor

Answer 41

Separately Traded Registered Interest and Principal Securities (STRIPS)

Question 42

• this term is the zero coupons issued by b/d’s

– this term is an escrow receipt backed by escrowed US Treasury securities

• sold at a steep discount and matures at face amount

– the difference between the two is considered interest income

• this term is generally AAA rated, but is not backed by the full faith and credit of the US government like STRIPS
• owning this term creates Phantom Income for the investor

Answer 42

Treasury Receipt (TR)

Question 43

• this term is income that the investor is required to pay taxes on even though they have not received it
• the accretion, or gain in value on a zero coupon that is either corporate or US Government related is taxed annually even though the investor will not receive the money until the bond matures
• this term applies to Treasury Receipts (TRs) and Separately Traded Registered Interest and Principal Securities (STRIPS)

Answer 43

Phantom Income

Question 44

• this term is a classification of government agencies that are not fully backed by the US Government
• these agencies have a line of credit from the US Treasury but are not backed by the full faith and credit of the US Government

Answer 44

Quasi-Governmental Agencies

Question 45

• this term can be purchased and sold through the Federal Open Market Committee
• this term is typically issued and/or guaranteed by any one of the following:

– an agency of the US Government; GNMA; and Government-Sponsored Enterprises

• these agencies buy qualified mortgage loans or guarantee pools of such loans originated by financial institutions, then securitize the loans and distribute the securities through the dealer community

Answer 45

Agency Mortgage Backed Securities

Question 46

• this term is a government-owned corporation within the Department of Housing and Urban Development
• also referred to as Ginnie Mae
• this is the only agency that is government-guaranteed
• buys FHA, VA, and Farmer’s Home Administration insured mortgages
• the bonds are issued as modified mortgage-backed pass-through securities with a minimum par value of $25,000
• quoted in 1/32 increments and settle T + 2. Denomination is usually $1,000
• pays interest monthly

Answer 46

Government National Mortgage Association (GNMA)

Question 47

• this government agency loans funds to savings and loans institutions with S&L mortgages as collateral
• the bonds issued have a par value of at least $10,000 and are short-term issues
• interest is paid semiannually

Answer 47

Federal Home Loan Bank (FHLB)

Question 48

• this government agency is also referred to as Fannie Mae
• this agency buys government guaranteed & insured mortgages as well as conventional mortgages from the banks
• this term is issued in conventional and short-term discount notes has a par value of at least $10,000
• interest is paid semiannually

Answer 48

Federal National Mortgage Association (FNMA)

Question 49

• this government agency is referred to as Freddie Mac
• this term buys conventional residential mortgages from financial institutions
• the bonds are participation certificates or pass-through securities and have a minimum par value of $25,000
• interest is paid semiannually

Answer 49

Federal Home Loan Mortgage Corporation (FHLMC)

Question 50

• this term is a derivative security that derives its value from an underlying pool of GNMA, FNMA, or FHLMC mortgage-backed securities
• this term can also be backed by a pool of mortgages that are not government agency securities
• this term carries interest rate risk, prepayment risk, and extension risk

– prepayment risk is the possibility that if interest rates fall, the maturity will shorten because homeowners are likely to refinance their home at lower interest rates

– extension risk is the risk that the investor receives the principal later than anticipated

• this term provides the investor with a monthly payment of both principal and interest
• this term is divided into several slices or Tranches

– each tranche is a separately traded bond with its own characteristics and risks

– the three classifications of tranches (from safest to riskiest) are: Planned Amortization Class (PAC); Targeted Amortization Class (TAC); and Z-Tranche

Answer 50

Collateralized Mortgage Obligation (CMO)

Question 51

• this term is another type of collateralized security that is backed by short term loans on assets other than real estate such as auto loans or credit cards

Answer 51

Asset-Backed Security

Question 52

• this term is backed by a pool of debt, such as loans, bonds or mortgages
• this term has a higher risk of default if they have a Junior Tranche (meaning they have lower priority of claim)
• this term can be callable by the issuer if there were no longer the income stream to support it
• there can also be a put feature which would allow the investor to sell this term back to the issuer

– both features are considered an enhancement to the product but are not always offered

Answer 52

Collateralized Debt Obligation (CDO)

Question 53

• this term, whether notes, bonds, or CDs, are based on US dollars in foreign repositories (mostly European)
• any entity can issue this term, including foreign corporations, domestic corporations, or municipalities

– the US Government is not permitted to issue this term

• this term’s bond maturities range from 5-10 years, pay annual interest, and are not subject to withholding taxes
• this term’s market has the following advantages to US corporations:

– no foreign exchange risk for US issuers (bonds denominated in US dollars); lower interest rates in comparison with domestic rates; lower issuance expenses (no SEC requirements)

Answer 53

Eurodollar Securities

Question 54

• this debt is generally short-term, high quality (investment grade) debt issued by corporations or municipalities
• one common form of this term is Commercial Paper

Answer 54

Money Market Debt

Question 55

• this term is unsecured corporate notes issued by blue chip companies
• this term is a well known form of Money Market Debt
• this term has a unique rating system for its instruments: P-1, P-2, or P-3, with P-1 being the highest rating
• has a maturity of at least 30 days and at most 270 days

Answer 55

Commercial Paper

Question 56

• this term is collateralized paper issued for the purpose of buying and reselling securities (from T-Bills to mortgages) typically overnight, from T-Bills to mortgages to provide short-term funds

Answer 56

Repurchase Agreements

Question 57

• this term is issued by states, cities, and counties
• it provides special tax privileges at the federal level (i.e. interest paid on this term is never taxed at the federal level)
• this term’s interest is not taxed in the state where it was issued but is taxed by other states
• capital gains are taxed at every level

Answer 57

Municipal Debt

Question 58

• this term is the process of incrementally reducing the book value for a premium-priced bond each year until it equals par value at maturity
• if the investor holds the bond until maturity, there is not capital gain or loss

– however, if the bond is sold before maturity, the capital gain or loss must be calculated

Answer 58

Amortization

Question 59

• this term is the process of incrementally increasing the book value of an OID municipal bond each year until it equals par value at maturity
• there is no gain or loss if the investor holds the bond until maturity
• this term applies only to municipal OIDs and zero-coupon bonds

Answer 59

Accretion

Question 60

• this term occurs when the issuer would like to reduce their cost of borrowing because interest rates have gone down or when an issuer would like to be released from a restrictive covenant
• there are two ways this term can occur:

– the first would be by issuing new bonds at a lower coupon rate or without the restrictive covenant

– the second would be to exchange the bonds that are currently outstanding with a new bond

Answer 60

Refunding

Question 61

• this term occurs occurs when interest rates have fallen and the issuer would like to call or refinance an outstanding bond with a higher interest rate

– this occurs with bonds that still have call protection

• the issuer locks in the lower rates by issuing a new bond today

– these bond proceeds will be used to retire the outstanding 8% bond on its call date

– the proceeds are deposited in an escrow account and invested in short-term treasury or agency bonds in the interim

• the original bond is referred to as the defeased and will now trade as a 2-year bond and be sold on a YTC basis
• the original bond is now AAA-rated because it’s backed by escrowed funds
• this process is disclosed int he covenant of defeasance for callable bonds (contained in bond indenture)

Answer 61

Advanced Refunding

Question 62

• this term is where the proceeds of the refunding issue are used to pay interest on the outstanding bonds until the bonds are called instead of being used to pay off the outstanding (original) bond

Answer 62

Crossover Refunding

Question 63

• this term is backed by full faith and credit, which means the overall or general taxing authority of the issuer (i.e. Sales Tax for state)

– this comes in the form of Sales Tax for states and then Ad Vaolorem (property) tax for cities/counties

• this term is included in the issuer’s debt limit, which establishes a ceiling for the total amount of GO debt that any community or governmental unit may issue
• this debt uses tax collections to make debt service payments and requires voter approval
• an analyst studies the debt statement which includes the overall debt for the municipality minus any self-supporting debt when analyzing this term

– an analyst also evaluates the demographics of the area (i.e. income per capita, economic diversification, issuer’s ability to collect taxes)

Answer 63

General Obligation Bond

Question 64

• this term is a part of total General Obligation Debt
• this term refers to a situation where multiple taxing authorities in a given geographic area have the ability to tax the same real estate

Answer 64

Overlapping Debt

Question 65

• this term is sometimes issued by a municipality and will limit the amount they will raise taxes for the bond issue
• for example, this term might only allow for a 1/2% sales tax to fund the municipal bond debt

Answer 65

Limited Tax Bond

Question 66

• this term is a form of General Obligation Debt
• it is backed by both revenue collections and taxes, however, the both revenue sources are considered insecure, inadequate, or insufficient
• this term cannot be marketed as Revenue Bonds because there is GO backing if the revenues fall short

– this means that this term must be included in the debt limit and must be underwritten by a Competitive Bidding Process

Answer 66

Double-Barreled Debt

Question 67

• this term is a category of bonds that is self-supporting because it is backed by user fees, revenues or special assessments that are collected from the facility or project
• this type of bond includes a bond indenture which identifies the promises made to the bondholders, and includes covenants for their protection
• this type of bond is project-centered (i.e. hospitals, toll roads, toll bridges, etc.)
• revenues are not backed by full faith and credit, but instead are backed by user fees

– this makes this type of bond less safe than General Obligation Bonds

• an analyst reviews feasibility studies, competing facilities, and the debt service coverage ratio when evaluating this term

Answer 67

Revenue Bond

Question 68

• this term is a type of Revenue Bond where the state legislative authority can appropriate money to pay off the bond issue

– it is not a legal obligation to pay off the bond issue

Answer 68

Moral Obligation Bond

Question 69

• also referred to as IDR Debt Securities
• this term is an industrial revenue bond
• if taxable, this term is subject to federal income tax and alternative minimum tax
• this term can be issued to construct sports stadiums and parking lots, which are both examples of taxable municipal bonds

– the bond is taxable because the municipal issue is often backed by a corporation which pays the principal and interest

• these bonds are often considered Private Purpose Bonds

– this means that the interest the investor receives is considered a preference item for AMT purposes

Answer 69

Industrial Development Revenue Bond

Question 70

• this term is a covenant found in the bond indenture of every Revenue Bond issue
• the issuer promises with this covenant to set user rates so that they are sufficient to pay interest and repay principal in the bonds

Answer 70

Rate Covenant

Question 71

• this term is a covenant in the bond indenture of every Revenue Bond issue
• with this covenant, the issuer promises to maintain the facility so that it continues to generate revenues to repay the bond holders

Answer 71

Maintenance Covenant

Question 72

• this term is a covenant in the bond indenture of every Revenue Bond issue
• this covenant states that if an extraordinary event (natural disaster or condemnation) occurs, the issuer collects on an insurance policy

– the insurance proceeds enable the issuer to pay off the existing bonds then the issuer issues new bonds to rebuild the project

Answer 72

Catastrophe Covenant

Question 73

• this term is a covenant in the bond indenture of every Revenue Bond issue
• this covenant states that the issuer will periodically contribute to a sinking fund, which is eventually used to retire the bonds at maturity or call them earlier

– the fund may only be used to retire the bonds

• a mandatory call is exercised if the sinking fund grows too rapidy

– this is because the issuer is not allowed to make money on the sinking fund

Answer 73

Sinking Fund Covenant

Question 74

• this term is found in the bond indenture of every Revenue Bond issue
• this term indicates which items will be paid first from the bond issue

– if the indenture contains a Net Revenue Pledge, then operation and maintenance are paid first and then debt is serviced. This pledge is most advantageous for investors

– if the indenture contains a Gross Revenue Pledge, then debt service on the bonds is paid first and operating and maintenance expenses are paid second

Answer 74

Flow of Funds

Question 75

• this term is issued by municipalities, corporations, and certain government agencies
• this term is a long-term bond with an interest rate that regularly resets through a Dutch Auction
• this term should trade as a short-term bond because of the regularly resetting interest rate
• this term is not classified as money market and are not necessarily liquid

Answer 75

Auction Rate Security (ARS)

Question 76

• this term is a taxable municipal bond that offers either a federal subsidy to the issuer or a tax credit to the investor
• this bond was created by the American Recovery and Reinvestment Act of 2009 and were issued from February 2009 until December 2010
• trades in the secondary market
• this bond was issued to fund public projects (i.e. highways)

Answer 76

Build America Bond (BAB)

Question 77

• this term is used for qualified small issuers
• the amount of money raised cannot exceed $10 million
• in communities with a small qualified issuer, the local bank may deduct up to 80% of the carrying cost when investing in the bonds or when they place them in their inventory to resell to investors

Answer 77

Bank Qualified Bond

Question 78

• this term is a financial instrument that represents a proportionate share in a specific pledged revenue stream, usually lease payments by a municipal or other government entity issuer
• investors receive a stream of income based on the lease revenues associated with the offering

Answer 78

Certificate of Participation (COP)

Question 79

• this term is issued by a state or local government, which means they are exempt from the rules of the Investment Company Act of 1940 and do not have to register with the SEC
• this term is regulated by the Municipal Securities Rulemaking Board (MSRB) instead of the SEC
• this term is exempt from federal taxes and often state and local taxes as well
• this term includes 529 college savings plans, ABLE accounts, and local government investment pools (LGIPs)

Answer 79

Municipal Fund Securities

Question 80

• this rule states:
• “When conducting municipal securities or municipal advisory activities, each broker/dealer, municipal securities dealer, and municipal advisor must deal fairly with all persons and must not engage in any deceptive, dishonest, or unfair practice

Answer 80

MSRB Rule G-17

Question 81

• this rule pertains to the reporting requirements of the underwriters of primary offerings of municipal funds securities
• the rule states that the “Underwriters must report information related to the offering no later than 60 days following the end of each semi-annual reporting period ending on June 30 and December 31”

– performance data must be reported annually, no later than 60 days following the end of the reporting period ending on December 31

– all information must be submitted electronically

Answer 81

MSRB Rule G-45

Question 82

• this term is a state-sponsored, tax-advantaged education savings plan
• contributions to this account are made with after-tax dollars and grow tax-deferred
• withdrawals are tax-free when used for Qualified Educational Expenses

– these expenses include tuition, mandatory fees, room and board, computers, and required books & supplies

• nonqualified withdrawals are subject to 10% penalty and ordinary income tax on gains
• the donor (owner) retains control of the account and may move the monies between any beneficiaries in the same family
• contributions are not limited but are considered a gift and are subject to gift tax rules
• most plans allow account holders to make an accelerated gift of 5 years’ worth of contributions with no gift tax liability if there are no other contributions during the 5-year period
• contributions may be tax deductible at the state level

Answer 82

529 Plan

Question 83

• this term allows an account holder to purchase units or credits at participating colleges and universities for future tuition and mandatory fees at current prices for the beneficiary
• this type of plan usually cannot be used to pay for future room and board at colleges and universities and do not allow you to prepay for tuition for elementary and secondary schools
• most of these plans are sponsored by state governments and have residency requirements for either the account holder or the beneficiary, or both
• these plans are not guaranteed by the federal government, but some state governments may guarantee the money that has been paid in
• if the beneficiary does not attend a participating college or university, the plan may only pay a small return on the original investment

Answer 83

Prepaid Tuition Plan

Question 84

• this term is an investment pool established by a state or local government entity to invest public funds
• this is a conservative investment due to liquidity requirements, budget constraints, legal restrictions, and limited investment options
• this term is a short-term investment with little volatility, designed to satisfy the needs for funds near term, even on a daily basis
• funds are pooled together in pools that typically combine cash of participating jurisdictions and invest in securities that meet the requirements of specific state laws relative to government investments

– the pooling of funds enables participants to take advantage of economies of scale

• this term is not required to register with the SEC and is exempt from SEC regulatory requirements for mutual funds
• administrators that operate as b/d’s are required to abide by MSRB rules, specifically those related to advertising and promotional materials
• appropriate investments for this term include:

– obligations issued or guaranteed by the US Government or related agency; Negotiable certificates of deposit from domestic banks; Commercial paper; Corporate notes; Money market mutual funds that are registered with the SEC; and Municipal obligations issued by state and local governments

Answer 84

Local Government Investment Pool (LGIP)

Question 85

• also referred to as 529A Accounts
• this term is a savings account for individuals with disabilities that provide tax advantages
• this term offers an individual with disabilities and their family a tax-advantaged way to save money for disability-related expenses
• the disabled person is the owner and designated beneficiary on the account
• annual contribution limit for this term is $15,000 per year

– total contribution limits vary by state

• contributions may be made by any person, including the account beneficiary, family & friends, using after-tax dollars
• contributions are not tax deductible on the federal level

– some states may allow for state income tax deductions for contributions made to this term

• earnings grow tax-deferred and withdrawals are tax free when used for qualified disability-related expenses, which include but are not limited to:

– Education; Housing; Transportation; Assistive technology; Employment training and support; Financial management; and Health care expenses

• eligibility to establish this term is limited to individuals living with significant disabilities

– additionally, the onset of the disability must have begun prior to age 26

• funds in this term are disregarded when determining eligibility for certain means-tested benefits programs (i.e. Medicaid and SSI)

Answer 85

ABLE Account

Question 86

• this term pertains to designating b/d’s (already acting as Adviser) as the underwriter for a Municipal issue
• this term indicates that the underwriters were determine by legal process
• when this term is used to select the underwriter, the advisor is required to disclose to any investor the involvement as both adviser to the issuer and now as underwriter
• most general obligation bonds underwritings are done on this basis

Answer 86

Competitive Bid

Question 87

• this term pertains to designating b/d’s (already acting as Adviser) as the underwriter for a Municipal issue
• this term indicates that the underwriter was simply selected by the issuer through negotiation
• when this term is used to select the underwriter, the adviser who is now participating in the underwriting must do the following:

– Terminate as adviser in writing; Disclose the total compensation as both adviser and as underwriter; and State in writing to the issuer that there is a strong potential conflict of interest in this dual capacity

• most revenue bonds underwritings are done on this basis

Answer 87

Negotiated Bid

Question 88

• this term is the most important publication in the primary municipal market
• it contains information that is very important to primary market participants, such as:

– 30-day visible supply, which is the total number of bonds coming to the market over the next 30 days

– Placement Ratio, which is the number of bonds placed divided by the number of bonds offered over the previous week

– Revdex, which is a yield index of 25 revenue bonds with 30-year maturities (i.e. stadiums & hospitals)

– GO Index, which is a yield index of 20 GO bonds with 20-year maturities

– Bond Buyer Municipal Bond Index (40-bond index), which is an index of the average price of 40 recently issued bonds with an average maturity of 20 years

– The 11 Bond Index, which is comprised of 11 GO bonds that are AA-rated with 20 years to maturity and is used as a benchmark for municipal bond yields

Answer 88

Daily Bond Buyer

Question 89

• this term is a wire service that provides the most up-to-date information on any news affecting the municipal industry

– this information is useful to underwriters in structuring and pricing new issues

Answer 89

Munifacts

Question 90

• this term is the compensation paid for underwriting, which is the difference between the offered price to the institutional public and the bid price to the issuer
• this term = Takedown + Manager’s Fee
• expressed in points, where 1 point = $10

Answer 90

Municipal Underwriting Spread

Question 91

• this term pertains to the additional takedown in a corporate underwriting
• the syndicate is functioning as dealer, principal, and taking the risk that the underwriting will sell

– thus, the additional takedown is paid to each member of the syndicate according to their bracket or retention (their percentage of the underwriting)

• this term is part of the total takedown

Answer 91

Syndicate Fee

Question 92

• this term is paid to the syndicate members who sell bonds, and also to the selling group, which has a written selling group agreement
• this term + Additional Takedown (Syndicate Fee) = Total Takedown

Answer 92

Selling Concession

Question 93

• this term is a type of quote in the Municipal Secondary Market
• this quote is for information purposes only and is not binding
• a dealer will place this quote to determine possible interest in one of its inventory positions

Answer 93

Bid Wanted

Question 94

• this term is a type of quote in the Municipal Secondary Market
• this quote is for information purposes only and is not binding
• a dealer places this quote to determine availability and price on a bond it wants to buy

Answer 94

Offer Wanted

Question 95

• this term is also referred to as a Workable Indication
• a dealer uses this term either when it needs to value a bond in its inventory or when the dealer needs an estimated market price to consider a trade
• this term is not a binding quote and is simply an estimate

Answer 95

Working Indication

Question 96

• this term is a firm quote given a dealer which is good for a specific time period (usually a hour)
• the dealer reserves the right to accelerate the deadline to 5 minutes at any time

Answer 96

Out Firm, With Five Minute Recall

Question 97

• this term is the MSRB system in which dealers report the sale and purchase of municipal bonds
• this system helps provide transparency into the municipal trading market to the public

Answer 97

Real-Time Transaction Reporting System (RTRS)

Question 98

• this term is an electronic system which provides information on municipal issuers to public customers as well as to professionals
• information available through this term include copies of the official statement as well as last trade information
• this term’s objective is to provide the most current information, thereby promoting transparency in the municipal marketplace

Answer 98

Electronic Municipal Market Access (EMMA)

Question 99

de information about instruments with short-term rates

– this information is based on input from at least 3 professionals who access this term through a password-protected website

Answer 99

Short-Term Obligation Rate Transparency System (SHORT)