Municipal Bonds 2 Flashcards by Danielle Lee

Once notice of sale has circulated, investment bankers interested in placing competitive bids for an issue form ______. An account that helps spread the risk of underwriting an issue among a number of underwriters

Syndicate

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To get info on the new issue, Syndicate Manager will order a New Issue Worksheet from The Bond Buyer which shows what 4 key columns of info?

Maturity Date
Years to Maturity
Number of Bonds
Bond Years - YTM x Number of Bonds

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Bond Years (on the New Issue Worksheet the Syndicate Manager uses) is used to calculate what 2 key factors in a new issue?

Average Life

2. Total Interest Cost

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How do you calculate Average Life of an issue, using the New Issue Worksheet?

Total Bond Years/Total Number of Bonds

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What are the demand drivers that firms considering forming a syndicate evaluate before doing so?

Demand for the security
Existence of presale orders
Determination and extent of liability
scale and spread
ability to sell the issue

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What document formalizes the relationship in a negotiated underwriting?

The Syndicate Contract or Agreement among Underwriters

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What document formalizes the relationship in a competitive bid?

Syndicate Letter or Agreement - not legally binding until submission of the bid

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A divided syndicate account where each underwriter is responsible only for its own underwriting allocation.

Western Account - less liability

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An undivided syndicate account where each underwriter is allocated a portion of the issue. After distribution, each underwriter is allocated their proportionate share of any unsold bonds - therefore liability may not end after distribution.

Eastern Account - more liability

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A syndicate is underwriting a $5mm issue. There are 5 syndicate members, each with equal participation. Your firm sells its entire allocation, but bonds worth $1mm remain unsold. If this is a western account, what is your firm’s liability? Eastern?

Western - no liability because entire allocation was sold. However, had any amount of the $1mm allocation to my firm was not sold, would be liable.
Eastern - unsold amount divided among all syndicate members based on their initial participation. In this example, your firm would be allocated 20% of the remaining $1mm or $200k

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The process of establishing the reoffering yield (or price) for each maturity

Writing the Scale

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A common calculation used for comparing bids and awarding the issue. It combines the amount of proceeds the issuer recieves with the total coupon interest it pays.

Net Interest Cost (NIC)

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Similar to NIC, but adjusted for TMV

True Interest Cost (TIC)

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What are bids with more than one interest rate called?

Split-rate bids

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How is interest cost determined on Split-rate bids?

The lowest average int. rate cost to the issuer

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The price at which the bonds are sold to the public by the syndicate

Reoffering Price of Reoffering Yield

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The syndicate’s compensation for underwriting the new issue is the _____, or the difference btw the price the syndicate pays the issuer and the reoffering price.

The spread, or the total sales generated from the municipal issue less the amount bid by the syndicate.

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Syndicate Management Fee is applied to what?

The spread

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The portion of the spread remaining after the syndicate management fee is called?

the total takedown. Members buy the bonds from the syndicate manager at the takedown.

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A syndicate member buys bonds from the manager for $991.25, sells them to the public for $1,000, and earns a takedown of 7/8 of a point or $8.75. If instead syndicate member choose to sell the bonds to a selling group (rather than the public) at $995, the selling group receives a $5 ____? What is the additional takedown the syndicate member receives from selling to selling group?

Concession or discount

Bought at $991.25 from manager
Sold to selling group for $995
Additional takedown = $3.75

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Total Takedown =

Concession + Additional Takedown (see pg. 132)

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Spread =

Total Takedown + Management Fee (see pg. 132)

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With respect to order allocation, what is entered before the date that the syndicate wins the bid, which means that a customer is willing to place an order without knowing the final price?

Presale Order - takes priority over all other orders; also, takedown is split among all syndicate members.

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After the bid is awarded, a syndicate member that wants a customer’s order to receive priority enters the order as what?

Group Net Order - takedown is deposited into syndicate account and, upon completion of underwriting, split between all syndicate members according to participation

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After Group Net Order, the next highest priority for orders is what?

Designated Order - usually from institutions that wish to allocate the takedown to certain syndicate members.

Lowest priority for orders is member or member-related orders in which a member firm enters such an order for what?

Its own inventory or related accounts, such as for a dealer-sponsored "unit investment trust" (UIT)

Acronym to remember order allocation priority?

``` Pro Golfers Dont Miss Presale Group Designated Member ```

Your manager notifies you that a new muni bond issue you've been working on is oversubscribed. How is the priority for acceptance of orders for this issue determined?

Outlined in the syndicate agreement

Who signs the syndicate agreement for a municipal bond issue?

All members of the underwriting syndicate

In a municipal underwriting, what is the first thing determined by the underwriting syndicate in calculating its bid? Also considered the yield at which the the syndicate plans to reoffer the bonds to the public.

The Scale

What is the most important factor in deciding who wins a bid?

Net Interest Cost

An order confirmed for the benefit of the entire underwriting syndicate placed after the bid is awarded is called what?

A Group Net Order

Refresher: what are the 3 main types of Muni's?

GO Bonds Revenue Bonds Muni Notes

What are the primary sources of municipal income?

Income tax & Sales tax --> State Income Real property taxes --> counties, school districts, cities City Income i.e. fines, fees, assessments, etc.

What do analysts use to determine the issuer's financial condition and understand whether the municipality may need to issue more debt in the future?

The documents in the Official Statement (recall that issuing more debt in the near future could damage an issuer's credit rating, which could cause the current issue to trade at a lower price)

What document is used in the analysis of GO debt that includes the estimated full valuation of taxable property, the estimated assessed value of property, and the assessment percentage?

The Debt Statement

Used to evaluate a municipality's debt structure, it is the sum of all bonds issued by the municipality.

Total Debt

Total Debt less self-supporting debt and sinking fund accumulations equals?

Net Direct Debt - includes GO's and short-term notes issued in anticipation of taxes or for interim financing.

The city's proportionate share of the county, school, park, etc debts.

Overlapping Debt

Net Direct Debt + Overlapping Debt = ?

Net Total Debt. ``` Total Debt - self-supporting debt - sinking fund accumulations = Net Direct Debt + overlapping debt = Net Total Debt ```

T/F: Revenue bonds are not subject to statutory debt limits.

True - Revenue bonds are not repaid from taxes, but are analyzed according to a facility's potential to generate enough money to cover opex and pay principal and interest. (meant to be "self-supporting")

If the facility that is financed from a revenue bond cannot repay the debt, who bears the risk?

Bondholders, not taxpayers

In a net revenue pledge (flow of funds), total receipts from a facility are deposited in what? And what is paid first? (after that, the balance is called "net revenues")

Revenue fund | Operations and Maintenance

In a gross revenue pledge (flow of funds), what is paid first?

Debt Service

How do you calculate debt service under a net revenue pledge?

Gross Revenue - Opex = Net Revenue | Divide Net Revenue by total debt service (princ & int)

``` A muni rev bond contains a net revenue pledge. The following are reported for the year: $30mm gross rev $18mm opex $4mm interest $2mm prinicipal What is the DSCR? ```

Net Revenue/Debt Service = DSCR Net Rev = $30-$18 = $12mm Debt Service = $4 + $2 = $6 DSCR = 2:1

T/F: Municipal bond prices do not tend to fluctuate more than government and corp bonds.

False - they tend to fluctuate more than gov or corp bonds because each issue is unique and may have few regular market makers.

Are insured bonds generally issued with a higher or lower coupon rate?

Lower Investors will accept lower rate of return for added safety and issuer may have to use lower yield due to the added cost of insurance.

Insured Bonds are typically implied to have what rating?

AAA

Where are muni bonds bought and sold?

OTC Market - most large brokerages maintain trading departments that deal exclusively in muni bonds.

What basis are muni bonds priced and offered for sale?

YTM basis - not dollar basis (aka "basis quote")

If a question mentions a 6% bond quoted on a 6.5 basis, which is the coupon and which is the YTM? Is it trading at a premium or discount?

6% = coupon 6.5 = YTM ("quoted on a 6.5 basis") YTM > Coupon --> trading at a discount

Premium or discount: 7% bond trading at 6.25% basis?

premium (could be getting paid 7% coupon, but have to buy it at 6.25% currently - not getting as much)

Premium or discount: 7% bond trading at 7.64% basis

Discount

A municipal bond quoted on a percentage of par dollar basis rather than yield basis is called what?

Dollar Bonds i.e. 104

A muni bond quoted at 104 means the price is?

104% of par ($1000) = $1,040

What type of quotation is a firm quote, meaning the the dealer is prepared to act?

A bona fide quote

What type of quotation indicates a dealer's estimate of a securities market value and are provided for informational purposes only?

A nominal (or subject) quotation

What type of quotation reflects a bid price at which a dealer will purchase securities from another dealer?

A workable indication

Muni securities dealers must report trades (sales) with other dealers to what organization?

NSCC - National Securities Clearing Corporation

A round lot for municipal bonds is usually what face amount?

$100,000

Municipal brokers that specialize in trading only with institutional customers, such as banks and other muni brokers, not with the retail public. Recall they focus on helping other muni dealers place unsold portions of new bond issues, act solely as agents, and do not maintain an inventory of bonds. They also do not disclose the identity of their customers.

Broker's brokers

Regarding suitability and recommendations of municipal bonds by b/d's to clients, the tax-free interest paid by muni bonds makes them better suited to those in (higher or lower) tax brackets.

Higher

Regarding suitability and recommendations of municipal bonds by b/d's to clients, the ability to receive tax-free interest payments means that these bonds (are suitable OR are not suitable) in an investor's tax-advantaged account like an IRA or 401K.

Are NOT suitable in tax-advantaged accounts. (research this one for clarity)

T/F: Muni bonds are best suited to those who list income as an investment objective.

True - they pay interest income (fixed-income in nature)

T/F: If a customer refuses to disclose net worth, income, or both, the account cannot be opened and recommendations cannot be made.

FALSE - The account can still be opened, BUT recommendations CANNOT be made.

When are firms subject to additional disclosure requirements?

When a control relationship exists - if the dealer controls, is controlled by, or is under common control with that security's issuer. i.e. an officer of a muni dealer sits on the board of directors of an issuer.

A dealer that arranges trades and charges commissions.

An agent

A dealer that buys and sells securities from its own inventory and charges a markup when it sells to customers and markdown when it buys from customers.

A principal

T/F: Markups and markdowns (principal profit) are not disclosed separately on a customer's confirmation.

TRUE - Markups/Markdowns are NOT disclosed

T/F: Commissions (agent profit) are disclosed on customer's confirmations.

TRUE - Commissions ARE disclosed.

With respect to disclosing yield on a customer confirmation, the yield on (callable OR noncallable) bonds is known with certainty and is therefore disclosed as yield to maturity.

The yield on non-callable bonds is known with certainty and is disclosed whereas the yield on callable bonds depends on whether or not the bond is called and trades at a discount or premium. Therefore, the MSRB requires that the yield shown on a customer confirmation be the lower of the YTM or YTC.

If interest rates have risen since issuance, causing the price to fall, the bond will trade at a (premium OR discount), and the issuer (is OR is not) likely to call the bonds because any refunding bonds would have to be sold at higher yields.

DISCOUNT | IS NOT

If interest rates have fallen since issuance, causing the price to increase and trade at a (premium OR discount), the issuer (is OR is not) likely to call the bonds because any refunding bonds can be sold at lower yields.

PREMIUM | IS

(Discount OR Premium) bonds are not likely to be called.

DISCOUNT

(Discount OR Premium) bonds are likely to be called.

PREMIUM

For discount bonds, is the lower of the yields the YTM or YTC?

YTM - revisit these concepts

For premium bonds, is the lower of the yields the YTM or YTC?

YTC - revisit these concepts

What are the 3 cases where no separate yield disclosure on the customer confirmation is required?

1. Variable rate bonds (reset bonds) - the coupon is adjusted periodically, yield computation is impossible. 2. Bonds in default - bond is no longer paying interest, yield comp is impossible. 3. Bonds sold at par - yield cannot be anything but the coupon rate

For zero coupon bonds, which are sold at a deep discount to par and pays no current interest, what is shown on the customer confirmation?

0%, must state that accrued interest is not calculated.

Which act restricted the federal income tax exemption of interest for municipal bonds to public purpose bonds, which are bonds issued to finance project that benefit citizens in general rather than particular private interests.

The Tax Reform Act of 1986

If a bond channels more than x% of its proceeds to private parties, it is considered a private activity bond and is not automatically granted federal tax exemption.

10%

When determining whether or not a tax-exempt bond is right for a particular investor, they should calculate what to see if the tax savings from the bond may be more attractive than a taxable bond paying a higher interest rate?

Tax-equivalent yield - determines a municipal bonds tax benefit (tax-free yield / (100% - investor's tax rate))

What calculation does this equation represent: (tax free yield / (100% - investor's tax rate))

Tax-equivalent yield.

An investor is in the 30% tax bracket. A muni bond currently yields 7%. To offer an equivalent yield, what must a corporate bond yield?

7% / (100% - 30%) = 10%

An investor is in the 30% tax bracket. A corporate bond currently yields 11%. What would be the equivalent muni yield?

11% x (100% - 30%) = 7.7%

T/F: Expenses associated with purchasing or holding muni bonds are not deductible. This includes interest on loans to acquire bonds, such as margin loans.

TRUE - due to the tax free nature of the interest income at the federal level

T/F: There is an exception to the "no interest deduction" rule for banks that purchase certain issues of GO bonds limited to a maximum face amount of $10MM.

True - these banks are allowed to deduct 80% of the interest carrying cost of the deposits funding the purchase of the bonds.