Municipal Debt Flashcards
The bond counsel will review all of the following sources to ascertain if a municipal issuer has the authority to sell bonds EXCEPT:
A. State constitution and judicial opinions
B. Validity of the signatures of the issuer’s representatives
C. Enabling legislation and local statutes
D. Securities Exchange Act of 1934
The best answer is D.
The bond counsel will review several sources to ascertain if a municipal issuer has the authority to sell bonds. The state constitution which gives those powers; any enabling legislation which affects the issuance of new bonds; any court opinions that are relevant; and the counsel will ascertain that the issuer’s representatives are authorized to sell the bonds.
Municipal bonds are exempt securities and not subject to the Securities Act of 1933 or the Securities Exchange Act of 1934, with the exception of the anti-fraud provisions.
Which statement is TRUE regarding the legal opinion of a new municipal bond issue?
A. Only new issue municipal revenue bonds have a legal opinion
B. Legal opinions are rendered by the Bond Counsel
C. Legal opinions are required by the SEC
D. Municipal issuers desire a qualified opinion
The best answer is B.
All new municipal issues (GO or revenue) have a legal opinion printed on the bond. The bond counsel renders an opinion as to the legality, validity, and tax exempt status of a new municipal issue. To do this, he or she examines municipal statutes, state laws, judicial edicts, and tax regulations.
An unqualified opinion is desired, meaning the bond counsel is satisfied that the issue is valid, legal, binding and federally tax exempt. If the bond counsel has any problems with the issue, then the opinion would be qualified by the bond counsel. New municipal issues with qualified legal opinions are virtually unmarketable.
In order to render an opinion on a new municipal bond issue, the bond counsel will examine all of the following EXCEPT:
A. Municipal statutes
B. State constitution and amendments
C. Tax code and interpretive regulations
D. Securities Act of 1933
The best answer is D.
The bond counsel renders an opinion as to the legality, validity, and tax exempt status of a new municipal issue. To do this, he or she examines municipal statutes, state laws, judicial edicts, and tax regulations.
Municipal securities, as well as Government and Agency securities, are exempt from the provisions of the Securities Acts (with the exception of these Acts’ broadly written anti-fraud provisions). Thus, these would not be examined by the bond counsel in connection with rendering a legal opinion.
The municipal bond counsel opines on all of the following EXCEPT:
A. validity
B. legality
C. marketability
D. constitutionality
The best answer is C.
The bond counsel examines new municipal issues for legal or tax problems and renders an opinion on the validity, legality and tax exempt status of the issue. Bond counsels do not render market or economic opinions, which is the same as rendering an opinion on the marketability of an issue.
A “qualified” legal opinion is one which:
A. gives a conditional affirmation of the legality of the securities
B. gives an unconditional affirmation of the legality of the securities
C. is given by a qualified bond counsel
D. qualifies the issue for a federal tax exemption from taxation
The best answer is A.
A qualified legal opinion is one where the bond counsel has found a legal or tax “problem,” and the counsel details the “qualification” in the opinion. Thus, the opinion is a conditional affirmation of the legality of the issue.
Which of the following projects would be financed by a general obligation bond issue?
A. The construction of a new subway line
B. The construction of a new junior high school
C. The construction of a new hydroelectric generating plant
D. The construction of a new sewage treatment plant
The best answer is B.
Public schools do not produce revenue and thus are not funded by revenue bond issues. Rather, school bond issues are general obligations of the issuer. A subway line, hydroelectric plant, and sewage treatment plant all charge for their use and can be financed with revenue bonds.
Which of the following actions must be taken if a municipality wishes to raise its debt limit?
A. Public referendum
B. Court order
C. Judicial edict
D. Tax assessment
The best answer is A.
If a municipality wishes to raise its debt limit, the voters must approve via a public referendum. In effect, the voters are approving an increase in their taxes when they approve such a measure.
Constitutional debt limits are imposed on:
A. self-supporting debt
B. non-self supporting debt
C. self-liquidating debt
D. all of the above
The best answer is B.
Municipalities impose debt ceilings on the dollar amount of bonds that can be issued backed by ad valorem taxing power (G.O. bonds). These are non-self supporting debts that are carried on the “backs” of taxpayers. To raise this limit requires a public referendum. Self supporting or self liquidating debts are financed by some enterprise activity. These are revenue bond issues. Since they pay their own way from the pledged revenue source only, they are not subject to constitutional debt limits.
All of the following are sources of income available for general obligation bond debt service EXCEPT:
A. ad valorem taxes
B. highway tolls
C. license fees
D. assessments
The best answer is B.
General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues. Highway tolls are pledged to pay the debt service on revenue bonds that are sold to finance the construction of the road. These monies are not available to pay the debt service on G.O. bond issues.
A municipality has issued a general obligation bond. Which of the following are sources of income is NOT available for debt service?
A. Ad valorem taxes
B. License fees
C. Fines
D. Tolls from a nearby Expressway
The best answer is D.
General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Ad valorem taxes, fines collected for paying taxes late, assessments of additional taxes, as well as fees collected that are not a specified income source for revenue bonds, are all sources of income backing G.O. issues. The Expressway tolls likely are revenue used to fund the highway and pay its debt service.
A municipality has a tax rate of 9 mills. A piece of real property in the municipality is assessed at $150,000 and has a fair market value of $155,000. The annual tax liability on the property is:
A. $1,350
B. $1,395
C. $13,350
D. $13,950
The best answer is A.
One mill = .001; 9 mills = .009. Taxes are based on assessed valuation, not fair market value. .009 x $150,000 = $1,350. Another way to think about it is that 1 mill = $1 of tax for each $1,000 of assessed value.
When does an investor receive payment of interest and principal on a Capital Appreciation Bond (CAB)?
A. Both interest and principal are paid at maturity
B. Interest is paid semi-annually and principal is paid at maturity
C. Both interest and principal are paid monthly
D. Both interest and principal are paid upon conversion
The best answer is A.
A Capital Appreciation Bond (CAB) is a municipal zero coupon bond with a “legal” twist to it. A conventional zero coupon G.O. bond is counted against an issuer’s debt limit at par value because the discount is treated as “principal.” If a new issue discount bond is legally crafted as a CAB, then the principal counted against the issuer’s debt limit is the discounted principal amount and the discount earned is considered to be interest income. The bond is purchased at the discounted price and then par is returned at maturity, with the 2 components of that par payment being the return of the discounted purchase price (the “principal” amount) and the accreted interest income.
Which of the following projects would be NOT financed by a revenue bond issue?
A. The construction of a new subway line
B. The construction of a new hydroelectric generating plant
C. The construction of a new junior high school
D. The construction of a new sewage treatment plant
The best answer is C.
Public schools do not produce revenue and thus are not funded by revenue bond issues. Rather, school bond issues are general obligations of the issuer. A subway line, hydroelectric plant, and sewage treatment plant all charge for their use and can be financed with revenue bonds.
Which of the following is NOT a revenue bond?
A. Water and Sewer bond
B. Tunnel Construction Bond
C. Construction bond for a new local library
D. Lease rental bond
The best answer is C.
General obligation bonds are backed by a taxing power pledge and are often used to pay for local free facilities such as libraries and schools. Revenue bonds do not have such backing - instead only the pledge of revenues from some enterprise activity backs the issue.
Industrial revenue bonds are a type of revenue bond where a corporation’s lease payments are the pledged source of revenue; a lease rental bond is another type of revenue bond where rent payments from a lessee of real property are the source of pledged revenue. Water and sewer bonds are also revenue bonds.
Which information would be found in a municipal bond resolution?
A. Any restrictive covenants to which the issuer must adhere
B. Any margin requirements for the issue
C. The credit rating assigned to the issue by a nationally recognized ratings agency
D. The compensation received by the underwriters for selling the issue to the public
The best answer is A.
The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions.
The credit rating is given by the ratings agencies (e.g., Moody’s or Standard and Poor’s); and is found in their publications.
The underwriter’s compensation is disclosed to investors in new negotiated municipal bond offerings in the Official Statement (the disclosure document, similar to a prospectus, for new municipal issues). Margin requirements are based on industry rules.
The Bond Resolution is the contract between the:
A. issuer and bondholder
B. bond counsel and issuer
C. bond counsel and bondholder
D. issuer and Municipal Securities Rulemaking Board
The best answer is A.
The Bond Resolution is the contract between the issuer and the bondholder. In the resolution will be found all covenants made by the issuer, including any call provisions.
All of the following are evaluated in the feasibility study prepared prior to the issuance of revenue bonds EXCEPT:
A. expected demand for the facility
B. effect of competing facilities
C. expected operating costs of the facility
D. bond trust indenture
The best answer is D.
The feasibility study performed prior to the issuance of revenue bonds is an economic study that projects revenues and costs for the facility to determine if there will be sufficient net revenues to service the debt. The effect of any competing facilities is included in the study. Legal aspects, such as the trust indenture, are not included in the feasibility study. These are evaluated by the bond counsel. The rest would be evaluated in the feasibility study.
All of the following are evaluated in the feasibility study prepared prior to the issuance of revenue bonds EXCEPT:
A. Expected demand for the facility
B. Effect of competing facilities
C. Bond trust indenture
D. Expected operating costs of the facility
The best answer is C.
The feasibility study performed prior to the issuance of revenue bonds is an economic study that projects revenues and costs for the facility to determine if there will be sufficient net revenues to service the debt. The effect of any competing facilities is included in the study.
Legal aspects, such as the trust indenture, are not included in the feasibility study. These are evaluated by the bond counsel.
The feasibility study prepared in connection with a new municipal revenue bond offering is performed by the:
A. issuer
B. underwriter
C. bond counsel
D. independent consultant
The best answer is D.
The feasibility study in a revenue bond offering is a projection of building costs; expected revenues; and expenses. The net result should show that the revenues anticipated from the project are sufficient to pay for both operation and maintenance of the facility and interest expense on the bonds issued to finance the construction, as well as cover the repayment of the bonds. This study is performed by an independent consulting firm.
Which of the following revenue bond issues would likely pledge the earnings from invested endowment funds to the bondholders?
A. Hospital bond
B. Water and Sewer bond
C. Mortgage bond
D. Turnpike bond
The best answer is A.
Hospitals and colleges are often given large monetary gifts - known as “endowments.” The institution invests the endowment funds to generate interest and dividend income. It usually agrees not to invade the principal amount. The earnings on the endowment funds are a source of revenue that can be pledged to bondholders under a revenue pledge.
What will back a municipal revenue bond?
A. Any municipal revenue collected
B. The specific revenue stipulated in the bond’s Official Statement
C. Taxes collected by the state of issuance
D. Taxes collected by the issuing municipal entity
The best answer is B.
A revenue bond is backed by a “revenue pledge” – these are specific revenues from an enterprise activity (such as the revenue from operating an airport financed with an airport revenue bond issue). Other revenues (such as the revenue from a nearby toll bridge) would be used to pay for a revenue bond issue used to finance the building of that bridge – not of the airport, making Choice A incorrect. Tax collections by states and municipal entities are used to back General Obligation bonds, not revenue bonds.
All of the following are sources of income can be used for debt service on municipal revenue bonds EXCEPT:
A. User Fees
B. Special Taxes
C. Capitalized Interest
D. Lease Rentals
The best answer is C.
A revenue bond is defined as a debt where payment of interest and principal is derived from a source other than ad valorem taxes. Thus, revenue bonds can be paid off by lease rental fees, user fees, and special taxes (such as excise taxes). Capitalized interest is not an income source; rather it is part of the cost of a construction project that is included in the total financing needs when building a facility.
Level debt service is best described as:
A. debt service remains the same amount each year
B. debt service decreases as the years progress
C. principal repayments decrease as the years progress
D. principal repayments stay the same as the years progress
The best answer is A.
Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.
Level debt service is best described as:
A. debt service increases as the years progress
B. debt service decreases as the years progress
C. principal repayments decrease as the years progress
D. principal repayments increase as the years progress
The best answer is D.
Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases; and the interest amount decreases. The total of the two remains the same. This is essentially the same idea as a mortgage amortization schedule.
From an issuer’s standpoint, as the years progress, “level debt service” serial bond issues have:
A. Decreasing interest payment amounts and decreasing principal repayment amounts
B. Decreasing interest payment amounts and increasing principal repayment amounts
C. Increasing interest payment amounts and decreasing principal repayment amounts
D. Increasing interest payment amounts and increasing principal repayment amounts
The best answer is B.
Level debt service means that the issuer pays the same amount each year, with the funds being used to pay both interest and a portion of principal on the issue (similar to a mortgage amortization schedule). Since bonds are retired annually, the amount of the payment representing interest declines annually. The balance of the level payment is used to pay off bonds for that year. Thus, each year, the principal repayment amount increases.
