Unit 6- Municipal Bonds

Question 1

What is a basis quote for a municipal bond?

Answer 1

Bond basis = yield to maturity

Note: 1 basis point is 1/100th of a percent

Question 2

Define: Dollar Bond

Answer 2

A bond that is quoted as a regular percentage of its par.

Question 3

Are municipal bonds exchange traded?

Answer 3

No….they are sold OTC

Question 4

What was created under the Security Act Amendments of 1975?

Answer 4

The MSRB

Question 5

Types of municipal bond quotations?

Answer 5

1) Bona Fide (firm)

• If a dealer posts a quote, they must be able to make good on the sale.
• A bona fide quote must reflect fair market value. It can also reflect the firms inventory. It does not have to be the best price.

2) Workable Indication

• The bid price a firm is willing to pay when they purchase a municipal bond from another firm. The bid may change as the market does.

3) Nominal (aka: subject) quote

• Is a dealers estimation of the market value of a security. MUST be labeled as such. Can be changed.

4) Holding quote (aka: out firm with recall quote)

• A deeper quote that is firm for a specific period of time (usually 1 hr). Can be recalled with a 5 min warning.

5) Bid wanted/Offer wanted

• Because municipal bonds are not exchange traded, investors often can the dealer for bid and quote prices.

Question 6

Who hires the bond counsel?

Answer 6

The issuer.

Question 7

Difference in maturity lengths between a municipal note and a municipal bond?

Answer 7

Municipal note = < 3 years

Municipal bonds = > 3 years

Question 8

What is in a trust indenture (aka: bond resolution)?

Answer 8

• Rate covenants
• Maintenance covenants
• Insurance covenants
• Additional bond test (opened or closed)
• Sinking fund
• Catastrophe clause
• Flow of funds
• Books and records covenant
• Call features

Note: Trust indentures are not required, but are desired.

Question 9

Another name for a variable rate municipal bond?

Answer 9

A “reset security” (because the interest rate resets)

Question 10

The two types of variable rate municipal securities?

Answer 10

Variable rate demand obligations (VRDO)

• interest may be reset daily, weekly, monthly, or even semiannually.
• Key feature: the investors have the option to sell the bond back to the issuer at par, on any reset date.

Auction Rate Securities (ARS)

• Interest rates are reset by Dutch auction every 7, 14, 28, and 36 weeks.
• No new ARSs have been issued since 2007.

Question 11

What document do municipal bonds offer, that is similar to a prospectus?

Answer 11

The Official Statement

Question 12

How to calculate a municipalities Net Total Debt?

Answer 12

Total debt (all bonds issued, GO and Rev.)

• Self-supporting debt (Rev. bonds)
• Sinking fund accumulations

= Net Direct Debt

+ Overlapping debt

= Net Total Debt

Question 13

Define: Debt Coverage Ratio?

Answer 13

Coverage = Available Rev / Debt Service Requirement

Question 14

How is the cost basis of a municipal bond adjusted over time?

Answer 14

Purchased at a premium = Amortized

Purchased at a discount = Accreted

Question 15

Are capital gains with a municipal bond tax free?

Answer 15

No…only the interest.

Question 16

What municipal securities are subject to Alternative Minimum Tax?

Answer 16

Private purpose, and nonessential government service municipal bonds. (Example: industrial revenue bonds)

Question 17

Items that add to alternative minimum tax?

Answer 17

• Private purpose municipal bonds.
• Research and development costs and excess intangible drilling costs of a DPP.
• State income and property tax, and interest on investments that do not generate income.
• Accelerated depreciation on investment property.

Question 18

Taxable municipal bonds (2 types)?

Answer 18

Build America Bonds:

• Direct payment BAB
• Tax credit BAB

Question 19

Does the MSRB regulate issues?

Answer 19

No…just forms and individuals involved in the municipal securities business.

Question 20

Who enforced MSRB rules?

Answer 20

FINRA

Question 21

Rules for records of associated people?

Answer 21

• Any change to U4/U5 must update in 30 days.
• Records must be kept for a minimum of three years after termination of an associated person.

Question 22

Length if time a record must be kept?

Answer 22

Lifetime:

• Articles of incorporation, or a partnership agreement.
• Minutes of a board or partnership meeting.
• Records of stock certificates.

6 Year Records

• Blotters
• General ledger
• Customer ledgers
• Customer account records
• Customer complaints (note: FINRA only requires 4 yrs)
• Principal designation records

All other records are considered to be a 4 year record.

NOTE: All records must be kept READILY AVAILABLE for 2 yrs.

Question 23

What is the “clearing rate”?

Answer 23

When a municipal bonds interest is reset at Dutch Auction, the new rate is called the clearing rate.

Question 24

Do catastrophe call clauses have to be stated on the customer confirmation?

Answer 24

No…only calls with a defined date.

Question 25

Bring the sale of a bond, is the current yield stated?

Answer 25

No…but the yield to maturity or clients call is.

Question 26

What is a municipalities collection ratio?

Answer 26

Collection ratio = property tax collected / property tax assessed

This is a measure used to see a municipalities ability to cover its GO debt obligations.

Question 27

What is the full and fair disclosure document (similar to a prospectus) of the municipal securities world?

Answer 27

The Official Statement

Question 28

Define: Bond Placement Ratio

Answer 28

Reported weekly:

$ NEW issues sold / $ NEW issues unsold

It’s a ratio of of new issues sold to those that didn’t sell. Basically it shows the success of the underwriters.

Question 29

What organization insures general obligation bonds?

Answer 29

National Public Finance Guarantee Corp. and AMBAC

Question 30

Can a broker dealer act as financial advisor and underwrite for a municipal security issuer?

Answer 30

No! This is true regardless of it it’s a competitive bid or negotiated underwriting.

IF an exception is made, the broker can only collect fees as an advisor, and can not profit from the underwriting.