Municipal Debt Securities--Bond Types and Tax Treatment Flashcards
What is the net yield for an investor in the 28% tax bracket who owns an 8.5% corporate bond?
The formula is: Taxable Yield x (100% - Tax Bracket %). 8.5 x 72% = 6.12%.
Bonds subject to the AMT will trade with a _________ yield.
Bonds subject to the AMT will trade with a higher yield.
How does the Dutch Auction set the interest rate on Auction Rate Securities?
It sets the lowest interest rate at which all the securities being offered will clear the market (net clearing rate).
In what covenant does the issuer pledge to keep the project in good working order?
Maintenance and Operation Covenant
What is level debt service?
Each year’s debt service payments remaining generally equal.
Municipal bond interest is exempt from __________ tax.
Municipal bond interest is exempt from federal tax.
The process of adjusting the basis of a premium bond down to par over its life is called _______________.
The process of adjusting the basis of a premium bond down to par over its life is called amortization.
The process of adjusting the basis of an Original Issue Discount bond up to par over its life is called ____________.
The process of adjusting the basis of an Original Issue Discount bond up to par over its life is called accretion.
What is the tax consequence if a municipal bond is purchased at a premium and sold prior to maturity?
A capital gain or loss determined by the difference between the adjusted basis and the proceeds of the sale
$9 million gross revenue, $3 million oper./maint. expenses, and $2 million debt service. Debt service coverage ratio?
($9 million - $3 million) ÷ $2 million = 3:1 coverage.
True or False: The Flow of Funds covenant on a revenue bond describes the priority for distributing project revenue.
True
A bond backed by a charge to benefiting property owners is called a __________________________.
A bond backed by a charge to benefiting property owners is called a special assessment bond (e.g., water/sewer system).
True or False: An increase in unfunded pension liabilities is a negative sign of the municipality’s creditworthiness.
True
What does 1 mill equal?
$1.00 per thousand dollars of assessed value (.001 as a decimal)
Local general obligation bonds are backed by what type of tax?
Property tax (e.g., school district bonds)
Assuming a net revenue pledge bond, what is the first priority according to the flow of funds?
Operating and Maintenance Fund
Define overlapping debt.
Debt of a municipality that is shared with another political entity (e.g., school district debt)
What is the tax consequence if a municipal bond is purchased at a premium and held to maturity?
Since the basis must be amortized down to par, there is no capital gain or loss when a premium bond is held to maturity.
A __________________ is a revenue bond backed by one specific tax.
A special tax bond is a revenue bond backed by a specific tax (e.g., bonds issued for highway repair backed by gas tax)
The formula for net (after-tax) yield is: __________ x (________- ________)
The formula for net (after-tax) yield is: Taxable Yield x (100% - Tax Bracket %)
What is the tax consequence if a municipal Original Issue Discount (OID) bond is sold prior to maturity?
A capital gain or loss determined by the difference between the adjusted basis and the proceeds on the sale
True or False: The credit rating of an IDR is based on the credit of the municipality.
False. The rating is based on the corporation making the lease payments.
What is a Revenue Anticipation Note (RAN)?
Municipal note that will eventually be paid from future federal or state subsidies
MIG stands for ___________________________.
MIG stands for Moody’s Investment Grade.
What is a municipal OID?
An Original Issue Discount (OID) bond.
Accrued interest on municipal bonds is calculated using ____ days in the month and _____ days in the year.
Accrued interest on municipal bonds is calculated using 30 days in the month and 360 days in the year
When analyzing GO bonds, what are some important considerations? 6
- Property values,
- per capita income and debt,
- population,
- current debt,
- tax collection,
- unfunded pension liabilities
An OID is sold prior to maturity. Is the capital gain (or loss) based on the original cost basis or accreted value?
The accreted value of the bond.
Moody’s rates municipal notes using ______, ______, ______, ______.
Moody’s rates municipal notes using MIG1, MIG2, MIG3, SG.
How often will VRDOs adjust their interest rate?
At specified intervals such as daily, weekly, or monthly. VRDOs may allow owners to put (sell) back to the issuer.
A muni. bond is bought at a secondary market discount and sold for a gain before maturity. What is the tax consequence?
The gain is taxable as ordinary income up to the accreted value, and a capital gain for any amount above that.
What is the tax consequence if a municipal Original Issue Discount (OID) bond is held to maturity?
Since the basis must be accreted up to par, there is no capital gain or loss when an OID is held to maturity.
The maximum maturity of commercial paper is ____ days.
The maximum maturity of commercial paper is 270 days.
Assuming a net revenue pledge bond, what is the second priority according to the flow of funds?
Debt Service (with Operating and Maintenance first)
What are Auction Rate Securities (ARS)?
Long-term bonds (municipal or corporate) with a variable interest rate set periodically through a Dutch Auction
Revenue bonds are backed by ___________________ generated by ________________________.
Revenue bonds are backed by specific revenue (user fees) generated by a project or facility.
Who may issue bonds that offer interest that is triple tax-exempt?
Commonwealths, territories, and possessions (e.g., Puerto Rico)
What is a Construction Loan Note (CLN)?
Municipal note issued to provide funds for construction of housing projects to be repaid by permanent financing
What is the tax consequence if a municipal bond is purchased at a secondary market discount and held to maturity?
The gain is taxed as ordinary income.
Mack, in the 35% tax bracket, is earning 5.4% on a tax-free municipal bond. What is his taxable equivalent yield?
The formula is: Tax-Free Yield ÷ (100% - Tax Bracket %). 5.4% ÷ 65% = 8.3%
What condition must exist for a municipal bond’s interest to be exempt at the state and local level?
Investors must buy the bond from the state in which they reside.
The formula for taxable equivalent yield is: __________ ÷ (________ - ________)
The formula for taxable equivalent yield is: Tax-Free Yield ÷ (100% - Tax Bracket %)
What types of municipal bonds are most likely subject to the Alternative Minimum Tax?
Private Activity bonds
What is the IRS method for accreting the basis of a bond?
Constant yield or constant interest method
How is the phantom interest on an OID treated for tax purposes?
It is considered interest income on a municipal bond, and therefore, tax exempt.
What bond would be issued to build a facility for a private company?
Industrial Development Revenue (IDR) bond
A decision of the ___________________ created the tax exemptions for government and municipal bonds.
A decision of the U.S. Supreme Court created the tax exemptions for government and municipal bonds.
How is property tax calculated?
Assessed value x millage rate
How is interest on municipal bonds treated for tax purposes?
Federally tax-exempt, but may be subject to state and local tax
Standard & Poor’s three ratings for municipal notes are ______, ______, ______.
Standard & Poor’s three ratings for municipal notes are SP-1, SP-2, SP-3.
Debt service represents the total of all ____________ and ____________ payments.
Debt service represents the total of all principal and interest payments.
To calculate Debt Service Coverage Ratio, the formula used is: (________ - ________) ÷ ___________
To calculate Debt Service Coverage Ratio, the formula used is: (Gross Revenue - O/M Expenses) ÷ Debt Service
What are some examples of tax-free money-market instruments?
Municipal notes and tax-exempt commercial paper
By what types of taxes are state general obligation bonds backed?
Income, sales, or gasoline tax, but also licensing fees and fines.
What is a Bond Anticipation Note (BAN)?
Municipal note issued for a capital project that will eventually be paid from the proceeds of a long-term bond
What two sources are used to pay debt service on a double-barreled bond?
Revenue dollars and tax dollars
True or False: If revenue falls short, payments on moral obligation bonds only begin with legislative approval.
True
What is a Grant Anticipation Note (GAN)?
Municipal note issued in anticipation of receiving government funding in the form of a grant
General Obligation (GO) bonds are backed by the issuer’s ________________________ and their ability to levy _______.
General Obligation (GO) bonds are backed by the issuer’s full faith and credit and their ability to levy taxes.
What is a Tax Anticipation Note (TAN)?
Municipal note issued in anticipation of future real estate taxes
True or False: The interest rate reset periods on Auction Rate Securities range from 7, to 28, or 35 days.
True
