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SIE Exam Prep 2 -- SANDBOX > Types of Bonds > Flashcards

Types of Bonds Flashcards

This deck focuses on the different types of bonds, including corporate bonds, US Government debt, municipal bonds, and money market instruments.

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SIE Exam flashcards
1
Q

An unsecured corporate bond

A

Debenture

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2
Q

Most senior form of corporate bond

A

Secured

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3
Q

Three examples of secured corporate bonds

A

Equipment trust certificates, mortgage bonds, collateral trust bonds

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4
Q

Agency debt that is backed in full by the U.S. government

A

Ginnie Mae

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5
Q

Considered the safest form of debt issued in the U.S.

A

U.S. Government bonds, notes and bills

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6
Q

Taxable at the federal level; may be exempt from taxation at the state level

A

U.S. Government bonds and notes

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7
Q

Corporate debt instruments with a maturity of no more than 270 days

A

Commercial paper

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8
Q

Maximum maturity of commercial paper

A

270 days

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9
Q

Bonds backed only by the good faith of the issuing corporation

A

Unsecured bonds or debentures

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10
Q

Protects bondholder through a written agreement between issuer and trustee

A

Trust Indenture

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11
Q

Typically backed by real estate holding of a corporation

A

Mortgage bond

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12
Q

Typically secured by other securities owned by the corporation

A

Collateral Trust bond

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13
Q

A debt instrument that allows a company to take possession of and enjoy the use of an asset while paying for it over time

A

Equipment trust certificates

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14
Q

Allow for the exchange of debt for equity issued by the same corporation

A

Convertible debt

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15
Q

The stated number of common shares a bondholder receives upon conversion

A

Conversion ratio

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16
Q

The point at which there is neither profit or loss in a conversion

A

Conversion parity

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17
Q

The amount of interest paid prior to maturity on a Treasury Bill

A

None, T-Bills are zero coupon securities

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18
Q

U.S. Government instrument that matures in 1 year or less

A

Treasury Bill

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19
Q

U.S. Government instrument that is quoted on an annualized discounted yield basis

A

Treasury Bill

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20
Q

U.S. Government instruments that matures within 2 -10 years

A

Treasury Note

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21
Q

U.S. Government instruments that typically mature in 20 - 30 years

A

Treasury Bonds

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22
Q

U.S. government instruments that are quoted in 32nds

A

Treasury Notes and Treasury Bonds

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23
Q

Inflation-indexed bonds issued by the U.S. Treasury

A

TIPS

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24
Q

U.S. government zero-coupon bond instrument that has no reinvestment risk

A

STRIP

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25
Q

Three government entities that issue mortgage-backed securities

A

Ginnie Mae, Fannie Mae and Freddie Mac

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26
Q

Investment risk most associated with mortgage-backed securities

A

Prepayment risk

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27
Q

Investment risk that coincides with early payment of a mortgage-backed securities

A

Reinvestment risk

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28
Q

Distinct maturity categories of CMOs

A

Tranches

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29
Q

Frequency of interest payments on mortgage-backed securities

A

Monthly

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30
Q

Mortgage-backed securities with the implied backing of the U.S. government

A

Fannie Mae and Freddie Mac

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31
Q

Debt securities that provide immediate term financing

A

Money market securities

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32
Q

The relationship of the coupon rate of a corporation’s convertible debt to its non-convertible debt

A

Lower

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33
Q

Type of corporate security that is backed by equipment

A

Equipment trust certificate

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34
Q

The stock price at which a convertible bond can be exchanged for shares of common stock

A

Conversion price

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35
Q

Act that requires the naming of a trustee to protect bondholders for corporate debt issues

A

Trust Indenture Act of 1939

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36
Q

Zero coupon securities created from U.S. Treasury notes and bonds by brokerage firms

A

Treasury receipts

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37
Q

Federal and state tax treatment of most municipal debt interest

A

Exempt from taxation at the federal level; may be taxable at the state level

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38
Q

Tax treatment of capital gains from sales of municipal bonds

A

Taxable

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39
Q

Entities authorized to issue municipal debt

A

U.S. territories, State governments, local taxing authorities like county and city governments and certain authorities

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40
Q

Full faith and credit municipal issues

A

General Obligation bonds

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41
Q

Backing for Municipal General Obligation Bonds

A

Municipality’s taxing authority

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42
Q

Three types of taxes that back bonds issued by states

A

Income taxes, license fees, and sales taxes

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43
Q

Type of tax that backs general obligation bonds issued by cities and counties

A

Property taxes (ad valorem taxes)

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44
Q

Overlapping debt that raises funds from the same taxpayer base

A

Coterminous debt

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45
Q

Revenue bonds that are also backed by taxing authority

A

Double-barreled bonds

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46
Q

Self-supporting municipal debt

A

Revenue bonds

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47
Q

Empowers a trustee to act in the best interest of the bondholders

A

Trust indenture (bond resolution)

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48
Q

Unique tax treatment of industrial development revenue bonds

A

Interest may be federally taxable

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49
Q

Type of self-supporting debt secured by sales, tobacco, fuel or business license taxes

A

Special tax bonds

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50
Q

State legislature may authorize funds to pay debt service when revenues or tax collections are insufficient

A

Moral obligation bonds

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51
Q

Maturity of typical municipal notes

A

12 months or less

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52
Q

Forms of short-term debt issued to finance current operations in anticipation of tax collections or revenue collections

A

TANs and RANs

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53
Q

Safety of this type of municipal debt is determined by assessing the municipality’s ability to raise enough tax revenue to pay its debt

A

General Obligation bonds

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54
Q

Statutory limits on the amount of debt a municipality can carry

A

Debt limit

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55
Q

The enforcement authority for MSRB rules concerning broker-dealers

A

FINRA

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56
Q

Equation for calculating tax-equivalent yield

A

Municipal tax free yield/100% - investor’s tax rate

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57
Q

Maximum political contribution allowed for municipal finance professional in a single election

A

$250

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58
Q

Type of municipal issue that may require voter approval through a referendum

A

General Obligation bonds

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59
Q

Considered the safest type of municipal issue

A

General Obligation bonds

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60
Q

Type of municipal issue most concerned with competing facilities

A

Revenue bonds

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61
Q

Type of municipal issue which may be impacted by debt limits

A

General obligation bonds

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62
Q

Tax calculation performed to ensure that deductions that have been claimed do not reduce tax liability beyond a certain minimum level

A

Alternative minimum tax computation

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63
Q

Interest on bonds of these two issuers is taxable at the federal, state and certain local levels

A

Corporations and agencies

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64
Q

Interest on bonds of this issuer is taxable at state and certain local levels, but is exempt from taxation at the federal level

A

Municipal

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65
Q

Interest on bonds of this issuer is taxable at the federal level but exempt from taxation at the state and local level

A

U.S. Government

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66
Q

Requires corporate bond issuers to appoint trustees to protect the interests of bondholders

A

Trust Indenture Act of 1939

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67
Q

ad valorem taxes

A

Property taxes, which are typically the main source of income for most counties, cities, towns, and villages. States, however, do not levy property taxes. They are based on the assessed value of a home or business, not the market value, and are used to pay the interest and principal on general obligation bonds.

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68
Q

adjacent municipalities

A

When two municipalities are next to one another and share in a debt offering (e.g., two cities next to each other). It is relevant in the analysis of GO bonds in order to determine the municipality’s net overall debt.

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69
Q

agency CMOs

A

These hold mortgage-backed securities that have been issued or guaranteed by a government agency. Because of this backing, they are typically safer and thus pay a lower yield.

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70
Q

alternative minimum tax (AMT)

A

A second method of calculating the tax liability for certain wealthy individuals to ensure they pay an appropriate amount of taxes.

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71
Q

assessed value

A

The value of a property as appraised for tax purposes. Property taxes are assessed in mills with one mill equaling 0.001 of the assessed value of the real estate.

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72
Q

asset-backed securities (ABS)

A

Pools of financial instruments that have been turned into bonds by broker-dealers. These are similar to mortgage-backed securities, except their portfolios include non-mortgage financial assets such as credit card debt and car loans.

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73
Q

banker’s acceptance (BA)

A

A money market instrument that is typically used to finance international trade.

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74
Q

bond anticipation note (BAN)

A

A short-term municipal note that is issued in anticipation of a future bond sale.

75
Q

bond quotation

A

States the price at which a bond is trading. Bond prices are typically quoted as a percentage of par. For example, corporate bonds are quoted as a percentage of par in increments of 1/8 of a point. T-notes and T-bonds are quoted as a percentage of par in increments of 1/32nds of a point. T-bills are quoted on a discounted yield basis, based on the discount from par they are trading at.

76
Q

bond referendum

A

The voting process by which new issues of proposed GO bonds can be approved if required by a municipality’s statutes or constitutions.

77
Q

certificates of deposit (CDs)

A

Time deposits issued by banks. A customer deposits cash with a bank for a fixed maturity and in return receives interest. If CDs are non-negotiable, they cannot be transferred or resold, which gives them limited liquidity, whereas negotiable CDs can actually be traded to other investors and therefore are considered money market securities.

78
Q

collateral trust bond

A

A type of secured corporate debt backed by securities (e.g., stocks) owned by the corporation.

79
Q

collateralized mortgage obligation (CMO)

A

A mortgage-backed security that has been structured by a broker-dealer and cut up into different pieces called tranches. Each tranche will vary based on expected maturity, credit quality, and exposure to prepayments.

80
Q

commercial paper

A

Unsecured, short-term corporate debt that typically has a maturity of 270 days or less.

81
Q

conversion price

A

The stated price at which a bondholder can convert a convertible bond into shares of common stock. This value is used to calculate the conversion ratio.

82
Q

conversion ratio

A

The number of shares of common stock that an investor will receive when she converts a convertible bond. It is calculated as the bond’s par value divided by the conversion price.

83
Q

convertible bond

A

A bond that offers investors the ability to convert into a fixed number of shares of the issuer’s common stock. Because the bond can be converted into shares of common stock, it generally trades like the underlying shares and less like a traditional bond. Additionally, because investors have this conversion benefit, these bonds pay a lower coupon rate than comparable non-convertible bonds.

84
Q

corporate bond

A

A fixed-income security issued by a corporation in order to raise capital.

85
Q

corporate resolution

A

A document provided by a corporation when establishing a brokerage account that specifies who will have trading authority.

86
Q

coterminous municipalities

A

When two municipalities, one falling within the borders of another, share in a debt offering (e.g., a city within a county). It is relevant in the analysis of GO bonds in order to determine the municipality’s net overall debt.

87
Q

covenants

A

Found in the trust indenture of a bond, they are promises by the issuer that are designed to protect the interests of bondholders. These covenants are established between the issuer and trustee, which is typically a large bank acting on behalf of the investors. They are required for corporate issuances in excess of $50 million, though many municipal revenue bonds have them as well. Examples of covenants include a requirement to maintain insurance or a certain credit profile.

88
Q

debt limit

A

Reflects the total amount of GO debt that a municipality can have outstanding at any time. The purpose is to protect residents from an overbearing tax burden, though the debt limit can typically be increased by a referendum. Municipalities that have outstanding debt well below these limits are generally viewed as offering greater safety to investors.

89
Q

debt service coverage ratio

A

A critical measure for analyzing the credit quality of municipal revenue bonds, it is calculated as the annual net revenues divided by the annual debt service. A higher ratio is preferred from a credit perspective.

90
Q

debt statement

A

Provides a comprehensive snapshot of the debts that a municipality has outstanding. Used for the analysis of GO bonds.

91
Q

discounted yield basis

A

The quote for a Treasury bill, which is expressed as an annualized discount rate from par.

92
Q

double-barreled bond

A

A type of municipal bond that is backed by both revenue and taxes. If there is a shortfall in revenue, lawmakers have a legal obligation to make up the difference in taxes.

93
Q

equipment trust obligation

A

A type of secured corporate debt backed by equipment such as a plane, train, or truck.

94
Q

extension risk

A

The risk that as interest rates increase, homeowners will no longer refinance their mortgages. Therefore, mortgages will remain outstanding for longer, and the mortgage-backed securities that are backed by these mortgages will see their maturity extended, keeping the investors’ money tied up for longer.

95
Q

Fannie Mae

A

A former government sponsored enterprise, now a publicly traded corporation, that issues mortgage-backed securities. Their issuances have the implied backing of the US government, though they are not fully guaranteed by the US government.

96
Q

Farm Credit System (FCS)

A

A government sponsored enterprise that provides loans to different entities within the agricultural sector.

97
Q

feasibility study

A

Used in the analysis of revenue bonds to help determine whether the project will generate enough revenue to cover the debt service as well as the overall economic viability of the project.

98
Q

Freddie Mac

A

A former government sponsored enterprise, now a publicly traded corporation, that issues mortgage-backed securities. Their issuances have the implied backing of the US government, though they are not fully guaranteed by the US government.

99
Q

flow of funds statement

A

Detailed in the trust indenture of a municipal revenue bond, it describes the order in which the revenue that is generated by the facility is used to pay the debt service as well as operating and maintenance expenses.

100
Q

Ginnie Mae

A

A government agency, which has the explicit backing of the US government, that issues mortgage-backed securities.

101
Q

general obligation bonds

A

Municipal bonds issued for a non-revenue-producing facility (e.g., a public park or public school). They are backed by the taxing power of the issuing municipality.

102
Q

index fund

A

A passively managed mutual fund that seeks to track the returns of a market index, for example, the S&P 500.

103
Q

industrial development bond

A

A type of private activity bond that is issued for the benefit of a private corporation. The interest on these is taxable by the federal government.

104
Q

jumbo CD

A

A type of certificate of deposit that can either be negotiable (transferable) or non-negotiable (non-transferable) that is issued in much higher denominations, typically between $100,000 and $1 million. They offer higher rates than smaller-denomination CDs.

105
Q

mortgage bond

A

A type of secured corporate debt backed by real estate property.

106
Q

moral obligation bond

A

A type of municipal bond that is backed by a revenue-producing facility and a non-binding pledge of the legislature. If there is a shortfall in revenue, the lawmakers, at their discretion, can make up the difference in taxes. However, this is a moral, not a legal obligation.

107
Q

money market

A

The fixed-income market that deals in short-term debt instruments with maturities of one year or less. Examples of money market instruments include T-bills, commercial paper, negotiable CDs, and banker’s acceptances.

108
Q

municipal note

A

A short-term municipal security that typically matures in one year or less.

109
Q

municipal advisor

A

A person or firm that provides advice to a municipality with respect to the issuance of municipal securities or the investment of proceeds generated from an issuance. Municipal advisors typically have a fiduciary responsibility to act in the best interest of the municipality.

110
Q

mortgage-backed securities (MBS)

A

Pools of mortgages that have been securitized and turned into bonds, typically by Ginnie, Fannie, and Freddie. These securities pay monthly interest to investors (similar to mortgages) and help to enhance the liquidity of the mortgage market.

111
Q

negotiable security

A

A security that can be freely transferred or traded between investors. Most securities are negotiable.

112
Q

negotiable CD

A

A type of certificate of deposit that can be traded to other investors in the secondary market. Because they can be traded, they are considered money market instruments. The minimum face value for a negotiable CD is $100,000.

113
Q

non-negotiable CD

A

A type of certificate of deposit that cannot be transferred or resold to another investor and can only be redeemed by the issuing bank. Because they cannot be traded, they are not considered securities and they do not trade in the money market.

114
Q

parity price

A

The market value at which an investor is indifferent between owning the convertible bond or the underlying common stock. The parity price of the stock is calculated as the market value of the bond divided by the conversion ratio, while the parity price of the bond is the market value of the stock multiplied by the conversion ratio.

115
Q

overlapping debt

A

Occurs when different municipalities have the ability to tax the same residents and tax source (e.g., both a city and county). It is relevant in the analysis of GO bonds in order to determine the municipality’s net overall debt.

116
Q

prepayment risk

A

The fact that as interest rates decrease, homeowners will refinance their mortgages in order to reduce their interest expense. As these mortgages and therefore the mortgage-backed securities are paid off, investors will receive their proceeds back at a time when rates are falling.

117
Q

private activity bond

A

A type of municipal bond that does not provide significant benefit to the general public and therefore the interest income is taxable by the federal government. Industrial development revenue bonds are an example.

118
Q

private-label CMOs

A

Sometimes referred to as non-agency CMOs, private-label CMOs hold mort-gage-backed securities that are backed by private issuers rather than by government agencies. Be-cause they are not issued or backed by Ginnie, Fannie, or Freddie, these are typically riskier and pay a higher yield.

119
Q

public purpose bond

A

A type of municipal bond which benefits the municipality at large. The interest income from these bonds is tax-free at the federal level, though the capital gains are taxable.

120
Q

repurchase agreement

A

A contractual agreement between two parties, in which one party agrees to sell securities to another party at a specified price with a commitment to buy them back at a later date at a slightly higher price. The higher repurchase price reflects interest to the lender. Repos are considered money market instruments.

121
Q

revenue anticipation note (RAN)

A

A short-term municipal note that is issued in anticipation of receiving future non-tax revenue

122
Q

revenue bond

A

A type of municipal bond issued for and backed by a revenue-producing facility (e.g., a toll road, airport, and water treatment facility).

123
Q

reverse repurchase agreement

A

The party in a repo, who agrees to buy securities from another party at a specified price with the commitment to sell them back at a later date at a slightly higher price. The higher sale price reflects the interest the lender receives. Reverse repos are considered money market instruments.

124
Q

secured corporate debt

A

A corporate bond that is backed by collateral.

125
Q

securitization

A

The process of converting a pool of financial instruments, such as mortgages or credit card loans, into bonds.

126
Q

self-supporting debt

A

A bond issue, such as a municipal revenue bond, where principal and interest payments are funded entirely from revenue that is generated by the project that was facilitated by the issue.

127
Q

senior securities

A

Securities, such as bonds and preferred stock, that have a priority over common stock in a liquidation.

128
Q

special assessment bond

A

A type of municipal bond that is backed by a tax on those who will directly benefit from the improvements the issuance provides. For example, the homeowners on a street pay for improvements to their sidewalk.

129
Q

special tax bond

A

A type of municipal bond that is backed by a tax on a complementary product. An example would be a tax on gasoline to help support the roads and highways in a country.

130
Q

STRIPS

A

Long-term, zero-coupon bonds that are backed by the federal government.

131
Q

subordinated debt

A

Unsecured corporate debt that has a lower claim on assets in a liquidation. In return for taking on more risk, investors receive a higher yield.

132
Q

tax anticipation note (TAN)

A

A short-term municipal note that is issued in anticipation of receiving future tax receipts.

133
Q

tax-free equivalent yield

A

A calculation that converts a taxable investment into a tax-free security in order to compare it to a tax-free municipal bond to determine which provides the better after-tax return. It is calculated as the tax-free yield divided by (100% minus the tax rate).

134
Q

taxable equivalent yield

A

A calculation that converts a tax-free municipal bond into a taxable invest-ment in order to compare the municipal security to a taxable investment to determine which provides the better after-tax return. It is calculated as the taxable yield multiplied by (100% minus the tax rate).

135
Q

territory bonds

A

Municipal bonds that are issued by US territories, including Guam, Samoa, Puerto Rico, and the US Virgin Islands. The interest income from these bonds is tax-exempt at the federal, state, and local levels for all US purchasers.

136
Q

TIPS

A

Treasury securities that help protect against inflation by having their principal increase semiannually based on the CPI.

137
Q

tranches

A

The unique classes of a CMO, each consisting of different credit qualities, expected maturities, and exposures to prepayments.

138
Q

Treasury bills

A

Marketable, short-term Treasury securities that mature in one year or less. They are zero-coupon securities that are issued at a discount and mature at par; they do not pay fixed interest. Because of their short maturity and government backing, they are regarded as one of the safest and most liquid debt securities.

139
Q

Treasury bonds

A

Marketable, long-term Treasury securities that typically mature in 30 years. They pay a fixed coupon and are quoted as a percentage of par value in increments of 32nds of a point.

140
Q

Treasury notes

A

Marketable, medium-term Treasury securities that typically mature within two to 10 years. They pay a fixed coupon and are quoted as a percentage of par value in increments of 32nds of a point.

141
Q

Treasury receipts

A

Long-term zero-coupon bonds that are structured by broker-dealers, but backed by the cash flows from Treasury securities. Once the US government began backing STRIPS, these became much less popular.

142
Q

Treasury securities

A

Marketable US-government-issued bonds, considered among the most liquid and safest fixed-income securities.

143
Q

triple-tax-free

A

The tax status of a public purpose municipal bond that is purchased by a resident of the state of issuance. The bond is tax-exempt at the federal, state, and local levels.

144
Q

Trust Indenture Act of 1939

A

Requires that corporate debt issuances of more than $50 million be issued with a trust indenture, which is a set of covenants that detail the obligations of the issuer and rights of the bondholders. These covenants are established between the issuer and trustee, which is typically a large bank acting on behalf of the investors.

145
Q

trust indenture

A

Consists of a set of covenants that detail the obligations of the issuer and rights of the bondholders. These covenants are established between the issuer and trustee, which is typically a large bank acting on behalf of the investors. Indentures are required for corporate issuances in excess of $50 million, though many municipal revenue bonds have them as well.

146
Q

trustee

A

An entity, typically a large bank, that is legally empowered to act in the best interest of bondholders by ensuring the issuer meets its covenants. This term is also used to describe the individual that is legally appointed to manage and act in the best interests of the beneficiary of a trust.

147
Q

unsecured corporate debt

A

Also referred to as debenture bonds, it is corporate debt that is not backed by an asset. Instead, it is backed by the good faith and credit quality of the issuer.

148
Q

How does the money market differ from the bond market?

A

Much Shorter Maturity

Although money markets have shorter maturities than the bond market, by defintion usually one year or less, they are just as important to funding the day-to-day operations of corporations and represent a very liquid, multi-billion dollar market.

149
Q

What is a repo agreement and why do banks use them?

A

To Raise Short Term Cash

If a broker-dealer needs to raise cash, it can sell collateral to another party with an agreement to repurchase that same collateral at a defined price at some point in the future. The difference between the original sale price and the repurchase price is the interest charged for this loan.

150
Q

For what purpose are bankers acceptance (BA) notes typically used?

A

To Finance International Trade

151
Q

Who issues commercial paper?

A

Corporations

Commerical paper is issued by corporations as is used to raise short-term cash. These securities typically have a maximum maturity of nine months (270 days).

152
Q

What are the specific tax benefits of U.S. government treasury bonds?

A

U.S. Treasuries are exempt from state and local taxes.

153
Q

For what return objective are T-Bills unsuitable for some investors?

A

T-Bills are very short term instruments sold at a discount and they provide no coupon payments. Because they have no cash flows, T-Bills, like treasuries, offer no current income. Investors seeking current income during a given period, such as retirement income, should avoid T-Bills.

154
Q

Describe how Treasury notes differ from T-Bills.

A
  1. Notes mature between 2 and 10 years versus T-Bills, which mature in one year or less
  2. Notes are issued with coupons and pay interest, unlike T-Bills, which are zeros
  3. T-Bills are quoted as a discount off of par, while T-Notes are quoted as a percentage of par in increments of 1/32
155
Q

Describe how Treasury bonds differ from T-Bills.

A
  1. Treasury bonds typically mature in 30 years whereas T-Bills have maturities of one year or less
  2. T-Bonds are issued with coupons and pay interest, unlike T-Bills, which are zeros
  3. T-Bills are quoted as a discount off of par, while T-Bonds are quoted as a percentage of par in increments of 1/32
156
Q

What types of government securities have no secondary market?

A

U.S savings bonds

There is no secondary market for these bonds and to be sold must be redeemed with the U.S. Treasury.

157
Q

What are the two government-sponsored enterprises (GSE)?

A
  1. Freddie Mac - Federal Home Loan Mortgage Corporation (FHLMC)
  2. Fannie Mae - -Federal National Mortgage Association (FNMA)

As GSEs, they are not formally backed by the government but are presumed to carry government backing – a presumption tested during the financial crisis.

158
Q

How is Ginnie Mae (GNMA) different from Fannie and Freddie?.

A

Fannie and Freddie are both government sponsored enterprised that have an implied but not explicit backing of the US government. Ginnae Mae is a government agency, which has an explicit backing of the US government and thus would be considered safer.

159
Q

Describe the basic structure of a Collateralized Mortgage Obligation (CMO).

A

CMOS are mortgage backed securities that have been structured by broker-dealers and cut up into different pieces called tranches. The various tranches will all vary in credit quality, expected maturity, and exposure to pre-payments.

160
Q

What are the two main types of munis typically issued?

A
  1. Revenue bonds - backed by a revenue producing facility
  2. General obligation (GO) - backed the taxing power of the issuing municipality
161
Q

For what types of projects do municipals use general obligation bonds?

A

Non-revenue projects

GOs are supported by the taxing authority of the municipality issuing the bond. They are used for projects that produce no revenue and will be paid for via taxes. These include basic service projects like public schools, public parks, and public buildings.

162
Q

What are ad valorem taxes?

A

Ad valorem taxes, also referred property taxes, help to support GO bonds that are issued by cities and counties. Property taxes are based on the assessed value of the property, which is taxed in mils. An investor will pay $1 of taxes for every $1,000 of assessed value.

163
Q

Who is entitled to collect property taxes?

A

Only the local city or county government

States are not allowed to collect property taxes so general obligations issued by the state depend on income, sales, and excise taxes.

164
Q

What is the primary protection for the investor in municipal general obligation issues?

A

Constitutional Debt Limits

Some states limit the amount of debt any municipality can take on and most municipalities require a vote before issuing debt. Both of these protect investors. The city and county have a legal right to raise property taxes to pay the bondholders. This makes the GOs the safest investment for the investor. However, a limited-tax bond is less safe for an investor because it caps the degree that a city or county can raise taxes and limits their ability to pay bond holders.

165
Q

What is the combination of a general obligation and revenue bond called?

A

Double-barrel bond

In a double-barrel bond, if the revenue is not sufficient, there is a legal obligation by the municipality to make up the shortfall from taxes.

166
Q

Where are the convenants of a revenue bond listed?

A

The Trust Indenture

This will contain all the obligations of the issuer as well as outlining specific protections that protect the investor. The indenture will also specify a trustee who will ensure compliance with the indenture.

167
Q

What are two of the most common types of covenants?

A
  1. Insurance covenant - the commitment to insure anything built with the revenue bonds
  2. Rate covenant - an assurance that usage rates will be kept high enough to maintain the project after completion.

Note: as much as the indenture is used by municipal issues, it isn’t required, as bonds are covered under the Trust Indenture Act of 1939, which does not require indentures. Because of their use in corporate debt, it has become common for municipal securities to follow suit.

168
Q

What is an industrial development revenue bond?

A

IDRBs are issued by a municipality to construct industrial facilities or factories that will in turn be leased to an occupant to start a business and create jobs. Their cash flow comes from the company making lease payments. Since the company makes payments, which in turn the municipality pays to bondholders, the industrial development bond will have the same credit rating as the corporation.

169
Q

What is the name for revenue bonds that are also backed by a non-binding pledge of the legislature?

A

Moral Obligation Bonds

These bonds are backed by a revenue producing facility and non-binding pledge of the legislature. If the revenue is not sufficient, the lawmakers, at their discretion, can make up the shortfall from taxes.

170
Q

What is short-term muni debt called?

A

Muni Notes

These are issued with maturities of a year or less and are typically issued with the expectation of future anticipated tax or non-tax revenues that the issuer will use to pay off the debt.

171
Q

What purpose does the official statement serve?

A

Primary disclosure document for munis

The official statement discloses material information to potential investors.

172
Q

What is the taxable equivalent yield of a municipal security?

A

Since municipal securities pay interest that is tax-free, in order to compare a tax-free income to a taxable interest paying instrument, the taxable equivalent yield must be calculated, This is done by dividing the tax-free yield by (100% minus the investor’s tax bracket).

173
Q

In a liquidation, where do bondholders stand relative to equity holders?

A

In the event of a liquidation, bondholders have senior status and they are in line for assetsahead of both common and preferred stockholders.

174
Q

What does the Trust Indenture Act of 1939 require?

A

The Act requires that corporate debt issuances of more than $50 million include a trust indenture. The indenture consists of a set of convenants (promises) that detail the obligations of the issuer and rights of the bondholders. The written agreement is made between the issuer and a trustee, typically a bank, that represents the interests of the bondholders.

175
Q

Which U.S. law governs corporate bonds?

A

The Trust Indenture Act of 1939

176
Q

How are Treasury bonds quoted?

A

Treasuries are quoted in 32nd of a point. So, a Treasury bond trading at 98-16, is trading at 98-16/32. This bond would have a dollar value of $985.

177
Q

Define convertible bond parity.

A

At parity, an investor is indifferent between holding the convertible bond or converting into the underlying shares of stock because either way they have the same total value.

178
Q

Which type of municipal bonds are serviced by the income generated from specific revenue-producing projects?

A

Revenue bonds

179
Q

What type of corporate debt is backed by legal a claim on some specified property of the issuer in the event of default?

A

Secured

Secured bonds are backed by collateral, to provide protection against issuer default.

180
Q

Securities issued by which U.S. agency are backed by the full faith and credit of the U.S. Government?

A

Government National Mortgage Association (Ginnie Mae)

181
Q

Rising rates tend to slow the prepayments on mortgage-backed securities. This risk is referred to as

A

extension risk

182
Q

Convertible bonds generally pay lower interest rates than non-convertible debentures of comparable risk because:

A

Investors are given the benefit to convert their shares into the company’s underlying equity

183
Q

Which of the following is/are true about debentures?

  1. Debentures are not backed by any specific collateral.
  2. If the issuer does not make interest and principal payments, debenture holders can declare the firm bankrupt and claim any unpledged assets to pay off the debentures
  3. Debentures have a higher yield than comparable secured bonds,
A

I, II, and III

Debentures are unsecured corporate debt. Because debentures are not backed by any collateral, they have higher yields than comparable secured bonds.

184
Q

Define:

U.S. Savings Bond

A

Non-marketable US securities that cannot be resold by investors and therefore have no secondary market. They must be redeemed directly with the Treasury.

SIE Exam Prep 2 -- SANDBOX (14 decks)

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