Bonds

A municipal bond which is secured by taxes OTHER than ad valorem taxes is a(n):
Correct Answer
A. Special tax bond
B. Industrial revenue bond
Incorrect Answer
C. Moral obligation bond
D. General obligation bond

The best answer is A. A municipal bond which is secured by taxes other than ad valorem taxes is a special tax bond.

Which of the following corporate obligations are NOT secured?
I Collateral trust certificate
II Subordinated debenture
III Commercial paper
IV Debenture
Incorrect Answer
A. I only
B. II and IV only
Correct Answer
C. II, III, IV
D. I, II, III, IV

he best answer is C. A secured bondholder has a lien on a specific asset of the company – such as securities given as collateral in the form of a collateral trust certificate. A debenture and subordinated debenture (a second layer of debentures issued after the first debenture offering of a company, where the second layer of debentures will be paid after the first layer – thus, they are “subordinate” to the first layer of debentures) are promises to pay without any liens on corporate assets. Commercial paper is a short term IOU and is only backed by the issuer’s promise to pay.

All of the following statements are true about Treasury Receipts EXCEPT:
Incorrect Answer
A. Treasury Receipts are U.S. Government bonds stripped of coupons
Correct Answer
B. Tax on interest earned is deferred until maturity
C. Interest and principal are paid at maturity
D. Tax on interest earned is due annually

The best answer is B. Treasury Receipts are U.S. Government bonds which have been stripped of coupons. The discount must be accreted annually, and the accretion amount is taxable as interest earned for that year. However, no monies are received from the issuer until maturity, when the security is redeemed at par. At this point, the owner receives the face amount but has no tax consequences (since the discount was taxed over the life of the bond).

Which of the following participate in the Eurodollar bond market?
I Domestic investment banks
II Foreign commercial banks
III Domestic commercial banks
IV Domestic thrift institutions
Correct Answer
A. I, II, III
B. II, III, IV
Incorrect Answer
C. I, III, IV
D. I, II, III, IV

The best answer is A. Thrift institutions do not operate in the foreign markets. They only conduct business in the State in which they are organized, with their primary purpose being to give mortgages on local real estate, funded by deposits raised locally. All the others participate in the Eurodollar bond market.

Which statements are TRUE regarding market index linked certificates of deposit?
I Early redemption can result in the imposition of a penalty of 3-5% of the principal amount invested
II The CD can only be redeemed on a specified date during each calendar quarter
III The rate of return may be capped to a limit that is lower than the return of the reference stock index
IV Market index linked CDs typically have a minimum life of 3 years
Incorrect Answer
A. I and II only
B. III and IV only
C. I, II, III
Correct Answer
D. I, II, III, IV

The best answer is D. Market Index Linked CDs are a type of “structured product” that consists of a “zero-coupon” synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance.

Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor’s 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This “early withdrawal” penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used.
Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.

Which of the following are the primary sources of information about the municipal secondary market?
I EMMA
II Bloomberg
III Munifacts
IV Daily Bond Buyer
Correct Answer
A. I and II
B. III and IV
C. I and IV
Incorrect Answer
D. II and III

The best answer is A. EMMA is the MSRB’s retail oriented website for municipal investors (EMMA stands for Electronic Municipal Market Access). It includes “RTRS” – the Real Time Reporting System, which reports municipal bond trades occurring in the secondary market. Bloomberg gives daily electronic quotes for dealer offerings of municipal and corporate bonds in the secondary market.

Munifacts is a wire service specializing in new issue (primary market) information. The Bond Buyer is a daily newspaper devoted to the municipal primary market. Both the Bond Buyer and Munifacts are published by the same company – essentially Munifacts is an electronic Bond Buyer with extra information on the municipal secondary market.

We will write a custom essay sample on
Any topic specifically for you
For only $13.90/page
Order Now
Which of the following ratio tests are applicable when analyzing a school district bond issue?
I Debt service coverage ratio
II Collection ratio
III Debt per capita
IV Debt to assessed valuation
Incorrect Answer
A. I and II only
B. III and IV only
Correct Answer
C. II, III, IV
D. I, II, III, IV

The best answer is C. School district bonds are G.O. issues, paid by unlimited ad valorem taxing power; applicable ratio tests would be debt per capita (How much debt is each citizen of the town responsible for?); debt to assessed valuation (How much debt is there outstanding against the real properties that are assessed taxes to pay for the interest expense on that debt?); and the collection ratio (Of the taxes assessed by the municipality, what percentage is actually collected?)

The ratio of pledged revenues to debt service requirement applies to revenue bonds. Pledged revenues are those pledged to pay debt service and any other requirements set in the bond contract. The bondholder has a lien on these revenues. The higher this ratio, the safer a revenue bond, since there is a greater ratio of revenues to cover debt service.

Which investment gives the LEAST protection against purchasing power risk?
A. 6 month Treasury Bill
Incorrect Answer
B. 10 year Treasury Note
C. 10 year Treasury “TIP”
Correct Answer
D. 10 year Treasury “STRIP”

The best answer is D. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Treasury “TIPS” are Treasury Inflation Protection Securities – the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. Treasury STRIPS are zero-coupon Treasury obligations – these have the highest level of purchasing power risk. In contrast, 6 month Treasury bills have a low level of purchasing power risk. Since they will mature at par in the near future, their value cannot fall very far below this if interest rates rise.

Which statements are TRUE regarding structured products?
I A “structured product” is a derivative security that is “structured” to have the characteristics of a debt, but give the higher returns typically associated with “equity” securities
II Structured products give a rate of return linked to an equity index such as the Standard and Poor’s 500 index
III Structured products have a fixed maturity at par in around 7 years based on an embedded option in the security
IV Structured products are standardized and liquid instruments
Incorrect Answer
A. I and II only
B. III and IV
Correct Answer
C. I, II, III
D. I, II, III, IV

The best answer is C. Structured products are securities based on, or derived from, a basket of securities, an index, or other securities, commodities or currencies. There are many types of structured products, but generally they consist of a “bond” portion, which pays interest based on the performance of a well known index such as the S&P 500 Index. In addition, they have a derivative component (an embedded option) that allows the holder to sell the security back to the issuer (at par) at maturity. These are often marketed as debt instruments, but that is not really the case. Structured products are created by many different brokerage firms and each firm’s version is somewhat different. Thus, they are not standardized, and they are fairly illiquid.

An individual who buys a $100,000 certificate maturing in 2021 would receive annual interest of:
A. $875
B. $890
Correct Answer
C. $8,750
Incorrect Answer
D. $8,900

The best answer is C. The bonds of 2021 have a stated interest rate of 8 3/4% x $100,000 principal amount = annual interest of $8,750. These bonds are initially offered at a discount to raise the effective yield of 8.90%.

Which of the following statements are TRUE regarding GNMA “Pass Through” Certificates?
I The certificates are quoted on a percentage of par basis
II The certificates are quoted on a yield basis
III Accrued interest on the certificates is computed on an actual day month / actual day year basis
IV Accrued interest on the certificates is computed on a 30 day month / 360 day year basis
A. I and III
Correct Answer
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is B. GNMA certificates are quoted on a percentage of par basis in 32nds. Accrued interest on “agency” securities is computed on a 30 day month / 360 day year basis. (Do not confuse this with the accrued interest on U.S. Government obligations, which is computed on an actual day month / actual day year basis).

Which of the following statements are TRUE regarding the trading of government and agency bonds?
I The trading market is very active, with narrow spreads
II Trading is confined to the primary dealers
III All government and agency securities are quoted in 32nds
IV The market is regulated by the Securities and Exchange Commission
Correct Answer
A. I only
B. I, II
C. II, III
Incorrect Answer
D. I, II, III, IV

The best answer is A. The government obligation trading market is the deepest and most active market in the world. Trading is performed by both the primary and secondary dealers, and by the Federal Reserve trading desk. While long term government and agency securities are quoted in 32nds, T-Bills are quoted on a discount yield basis. The market is unregulated – these are exempt securities under the Securities laws, however the Federal Reserve does exert influence over the primary dealers.

A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive:
A. $500
Correct Answer
B. $515
C. $1,000
Incorrect Answer
D. $1,030

The best answer is B. If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract. 103% of $500 = $515.

Which of the following is the shortest term money market instrument?
A. Commercial Paper
Incorrect Answer
B. Banker’s Acceptance
C. Negotiable Certificate of Deposit
Correct Answer
D. Federal Funds

The best answer is D. Loans of Fed Funds are made “overnight,” so the duration of the loan is 1 day. This, along with an overnight repurchase agreement, is the shortest term money market instrument.

Treasury bills:
I are issued in minimum $100 denominations
II are issued in minimum $10,000 denominations
III mature at par
IV mature at par plus accrued interest
Correct Answer
A. I and III
Incorrect Answer
B. I and IV
C. II and III
D. II and IV

The best answer is A. Treasury bills are original issue discount obligations that mature at par, in minimum denominations of $100 each.

A corporate security with at least 5 years to maturity is a:
Incorrect Answer
A. Money market instrument
Correct Answer
B. Non-callable funded debt
C. Treasury bill
D. Treasury note

The best answer is B. The term “funded” debt refers to corporate debt that is considered part of a company’s permanent long term financing. Included is all corporate debt with 5 years or more to maturity.

The interest received from older “tax free” Industrial Development Bond (IDBs) issues is taxable if the holder of these bonds is:
A. a customer
Incorrect Answer
B. a broker/dealer
Correct Answer
C. the corporate lessee
D. a bank

The best answer is C. The interest income earned from Industrial Development Bond Issues that were issued prior to 1986 was generally tax exempt. The lease payments made by the corporation are used to fund the interest payments made on the outstanding debt. These lease payments are tax deductible to the corporate lessee. If the corporation were to buy the outstanding bond issue, it would receive interest payments on the bonds that are tax free. Effectively, the corporation has taken a tax deduction for the lease payments; and has converted these payments into tax free interest income. The IRS does not allow this. If the purchaser of the bonds is a “substantial user” of the facility being leased, then the interest income received becomes taxable to the corporate lessee.

The revenue fund consists of:
A. monies to pay for extraordinary maintenance or replacement costs
B. monies to pay for regularly scheduled major repairs and replacement costs
Incorrect Answer
C. monies to meet debt service requirements
Correct Answer
D. all gross revenues from the facility

The best answer is D. Under the flow of funds (which states the priority of collecting and disbursing pledged revenues), the revenue fund would contain all gross revenues from the facility. All monies to be disbursed are taken from this fund.

If a municipality is expecting to receive federal funding for mass-transit programs, it could borrow against the expected funds to be received by issuing:
A. BANs
Incorrect Answer
B. TANs
Correct Answer
C. GANs
D. CLNs

The best answer is C. GAN stands for “Grant Anticipation Note.” A GAN can be issued by a municipality to “pull forward” and get immediate use of federal grant monies that are expected to be received in the upcoming months. These federal grant monies are used for mass transit, energy conservation and pollution control improvements.

All of the following statements are true regarding CMOs EXCEPT:
Correct Answer
A. CMO holders are paid interest semi-annually
Incorrect Answer
B. as interest payments on the underlying mortgages are received, they are distributed pro-rata to all tranches
C. as mortgages are prepaid, payments are applied to earlier tranches first
D. CMOs are a derivative security

The best answer is A. CMO holders are paid interest monthly, not semi-annually. As payments are received from the underlying mortgages, interest is paid pro-rata to all tranches; but principal repayments are paid sequentially to the first, then second, then third tranche, etc. Thus, as mortgages are prepaid, payments are applied to earlier tranches first. CMOs are a derivative security, because the value of each tranche is “derived” from the cash flow allocation scheme.

The type of municipal bond issue that would be used to finance the construction of public schools would be a:
A. revenue bond
B. special tax bond
Incorrect Answer
C. moral obligation bond
Correct Answer
D. general obligation bond

The best answer is D. 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. Special tax bonds pledge collected “special taxes,” such as excise taxes, to pay for the financing of a project. For example, a road improvement district bond issue could be financed by a special gasoline tax. A moral obligation bond is only issued in times of municipal distress, when the municipality does not have enough taxing power or revenue generating ability to sell a normal bond issue. To bail out the local municipal issuer, the state can morally obligate itself to pay if the municipal issuer cannot.

A 9%, $1,000 par corporate bond is trading at $1,100. What is the current yield?
Correct Answer
A. 8.18%
Incorrect Answer
B. 9.00%
C. 9.60%
D. 10.30%

The best answer is A. Since the bond is trading at a premium, its current yield must be lower than its coupon. The formula to find the current yield is:

$90
$1,100 = 8.18%

Zero-coupon bonds trade:
A. and interest
Incorrect Answer
B. with accrued interest
Correct Answer
C. flat
D. at par
The best answer is C. Zero-coupon bonds do not make semi-annual interest payments, therefore they trade “flat” – that is, without accrued interest. The term “and interest” means trading with accrued interest.
The term “Funded Debt” refers to which of the following issues?
A. Commercial paper with under 270 days to maturity
Incorrect Answer
B. Revenue bond with at least 5 years to maturity
Correct Answer
C. Corporate debt with at least 5 years to maturity
D. Treasury bond with at least 5 years to maturity

The best answer is C. The term “funded debt” refers to CORPORATE debt that is considered part of a company’s permanent long term funding. Included is all long term corporate debt. Revenue bonds are issued by municipalities and T-Bonds are issued by the Government. Commercial paper is a short term financing and is an “unfunded” debt.

A 15 year 3 1/2% Treasury Bond is quoted at 98-4 – 98-9. The bond pays interest on Jan 1st. and Jul. 1st. A customer sells 5M of the bonds. Approximately how much will the customer receive, disregarding commissions and accrued interest?
Correct
A. $4,906.25
Incorrect Answer
B. $4,914.05
C. $4,920.00
D. $4,945.00

The best answer is A. “5M” means that the customer is selling $5,000 par value of the bonds (M is Latin for $1,000) The customer sells to the dealer at the bid price, which is 98 and 4/32nds = 98.125% of $5,000 par = $4,906.25.

For bonds trading at a premium, rank the yield measures from lowest to highest?
I Nominal
II Current
III Basis
A. I, II, III
Correct Answer
B. III, II, I
Incorrect Answer
C. II, I, III
D. I, III, II

The best answer is B. When bonds are trading at a premium, the yield to maturity will be the lowest measure since the annual return is reduced by the annual amortized portion of the premium that will be “lost” over the life of the bond. Current yield will be higher than yield to maturity, since it does not include the annual premium loss. Stated yield will be the highest since it is the return based on par value.

A customer buys 5M of 6 1/4% Treasury Bonds at 100. How much interest income will the customer receive at each interest payment?
A. $31.25
B. $62.50
Correct Answer
C. $156.25
Incorrect Answer
D. $312.50

The best answer is C. “5M” means that 5-$1,000 bonds are being purchased (M is Latin for $1,000). Annual interest on the bonds is 6.25% of $5,000 face amount equals $312.50. Since interest is paid twice per year, each payment will be for $156.25.

The LEAST liquid money market instrument is:
A. Treasury Bills
B. Commercial paper
Correct Answer
C. Banker’s Acceptances
Incorrect Answer
D. Repurchase Agreements

The best answer is C. Banker’s Acceptances are a money market instrument used to finance imports and exports with Third World countries. The bank agrees to pay a fixed amount at a date in the future, which is the expected date of receipt of the goods. The exporter then has assurance that he will be paid and will ship the goods. BAs trade at a discount to their face amount until maturity, but the trading market is rather thin since the use of BAs is declining as international payment systems are modernized.

Which statements are TRUE about the risks associated with federal agency securities?
I Agency securities have market risk
II Agency securities have virtually no market risk
III Agency securities have credit risk
IV Agency securities have virtually no credit risk
A. I and III
Correct Answer
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is B. U.S. Government Agency Bonds (as with any fixed income security), have market risk. If interest rates rise, their prices will drop, with longer maturity and lower coupon issues dropping much faster than shorter maturity and higher coupon issues. Agencies also have virtually no credit risk since they are implicitly backed by the U.S. Government (with the exception of Ginnie Mae issues which are directly backed).

During periods when the yield curve is inverted, which statements are TRUE?
I Debt defaults are probably at historically high levels
II Issuers are likely to sell non-callable bonds
III Debt investors expect that interest rates will fall in the future
IV Debt investors expect that economic activity will decline
Incorrect Answer
A. II, III, IV
B. I, II, III
Correct Answer
C. I, III, IV
D. I, II, III, IV

The best answer is C. When the yield curve is inverted, short term rates are higher than long term rates. This typically occurs when the Federal Reserve pursues a “tight money” policy to slow the economy. The tightening of credit raises interest rates overall, slows economic activity, and thus business defaults increase. Long term rates remain lower than short term rates since investors do not expect the tightening to last far into the future. During periods when the yield curve is inverted, interest rates on all maturities tend to shift upwards, with short term rates rising the most. During these periods of high interest rates, issuers are likely to sell callable issues (not non-callable ones). If interest rates decrease in the future (as expected), the issuer can call in the old debt and refinance at lower current interest rates.

A basis quote for a $5,000 municipal bond with one year left to maturity has just been dropped by 20 basis points. The bond’s change in price will be:
A. $1 increase
B. $1 decrease
Correct Answer
C. $10 increase
Incorrect Answer
D. $10 decrease
100 Basis Points equal:
A. $.01
B. $.10
Incorrect Answer
C. $1.00
Correct Answer
D. $10.00

The best answer is D. One basis point = .01% in interest, or .01% of $1,000 par in annual interest = $.10. 100 basis points equal 1% of annual interest on a $1,000 per bond = $10.00.

A municipal variable rate demand note:
I is considered to be a short term issue
II is considered to be a long term issue
III gives the issuer the right to call the bond from the holder on pre-set dates
IV gives the holder the right to put the bond to the issuer on pre-set dates
A. I and III
Incorrect Answer B. I and IV
C. II and III
Correct Answer D. II and IV

The best answer is D. A municipal variable rate demand note is a long-term municipal security because it has no stated maturity, but it is issued at short-term (lower) interest rates, because the holder has the right to “put” the bond to the issuer at par at each interest payment date. The interest rate is reset, usually weekly at the interest payment date, to an indexed rate for the next week. Thus, the interest rate will vary. With any variable rate note, the interest rate varies as market rates move; therefore the market price remains at, or very close to, par. Thus, these instruments have almost no market risk.

The listing of current municipal bond offerings shows the following:
Cook County School District Bond
P/R @ 102 4.20 6/15/15 M’25 2.50
Which of the following statements are TRUE?

I The bonds will be redeemed in 2015
II The bonds will be redeemed in 2025
III The redemption price is par
IV The redemption price is 102

A. I and III
Correct Answer
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is B. The School district bonds have a coupon of 4.20% and were scheduled to mature in 2025. However, the issuer has pre-refunded (P/R) the bonds by escrowing U.S. government securities to retire the bonds prior to maturity (at the call date of 6/15/15). At that time, the bondholder will receive 102 (call premium of 2 points). The bonds are currently being offered at a price to yield 2.50%, so they are trading at a premium (coupon is 4.20%).

An investor in the 28% tax bracket buys a 7% municipal bond quoted on an 7.25 basis. To calculate the equivalent taxable yield:
A. divide 7% by 28%
Incorrect Answer B. divide 7% by 72%
C. divide 7.25% by 28%
Correct Answer D. divide 7.25% by 72%

The best answer is D. The formula for the equivalent taxable yield is:

7.25%
(100% – 28%) = 7.25%
.72 = 10.07%

Which statements are TRUE regarding the principal repayments for Companion CMO tranches?
I Principal repayments made earlier than expected are applied to the Companion class prior to being applied to the Planned Amortization class
II Principal repayments made earlier than expected are applied to the Planned Amortization class prior to being applied to the Companion class
III Principal repayments made later than expected are applied to the Companion class prior to being applied to the Planned Amortization class
IV Principal repayments made later than expected are applied to the Planned Amortization class prior to being applied to the Companion class
A. I and III
Correct Answer
B. I and IV
Incorrect Answer
C. II and III
D. II and IV

The best answer is B. Newer CMOs divide the tranches into PAC tranches and Companion tranches. The PAC tranche is a “Planned Amortization Class.” Surrounding this tranche are 1 or 2 Companion tranches. Interest payments are still made pro-rata to all tranches, but principal repayments made earlier than that required to retire the PAC at its maturity are applied to the Companion class; while principal repayments made later than expected are applied to the PAC maturity before payments are made to the Companion class. Thus, the PAC class is given a more certain maturity date; while the Companion class has a higher level of prepayment risk if interest rates fall; and a higher level of so-called “extension risk” – the risk that the maturity may be longer than expected, if interest rates rise.

Which statements are TRUE regarding repurchase agreements effected between the public and government securities dealers?
I The public customer is the seller of the government securities
II The public customer is the lender of monies
III The government dealer is the seller of the government securities
IV The government dealer is the lender of the monies
A. I and III
Incorrect Answer
B. I and IV
Correct Answer
C. II and III
D. II and IV

The best answer is C. When a government dealer enters into a repurchase agreement with the public, the dealer is “getting liquid” by selling government securities to the customer, with an agreement to buy them back at a later date. Thus, the customer is lender of cash to the government dealer.

As stated in the flow of funds found in a revenue bond issue’s trust indenture, monies to meet debt service requirements are deposited to the:
Incorrect Answer
A. Revenue Fund
B. Debt Service Reserve Fund
Correct Answer
C. Sinking Fund
D. Surplus Fund

The best answer is C. Monies to meet debt service requirements are deposited to the sinking fund. The bondholders are paid their annual debt service requirements from this fund. The Debt Service Reserve fund is used for “extra” deposits above and beyond the annual requirement.

The ratio that shows how well the municipality manages its cash receipts is the:
A. debt per capita ratio
Correct Answer
B. collection ratio
Incorrect Answer
C. pledged revenue to debt service requirements ratio
D. debt to assessed valuation ratio

The best answer is B. The collection ratio of a municipality is:

One looks for a very high ratio (better than 95%), meaning that the municipality is truly collecting the taxes it is assessing.

Corporate bonds are usually:
I serial bonds
II term bonds
III quoted on a percentage of par basis
IV quoted on a yield basis
A. I and III
Incorrect Answer
B. I and IV
Correct Answer
C. II and III
D. II and IV

The best answer is C. Corporate bonds are usually term bonds – all bonds of an issue having the same interest rate and maturity. Term bonds are quoted on a percentage of par basis in 1/8ths, which is the same as a “dollar” quote.

Which of the following municipal bonds would MOST likely be refunded by the issuer?
A. 5% G.O., M ’34, callable in 2015 at par
B. 6% G.O., M ’34, callable in 2015 at 102
Incorrect Answer
C. 7% G.O., M ’34, callable in 2015 at 102
Correct Answer
D. 8% G.O., M ’34, callable in 2015 at par

The best answer is D. In a refunding, an issuer refinances an outstanding debt by issuing new bonds. The proceeds of the new issue are used to retire the old debt; or are placed in escrow to “pre-refund” an older issue that cannot be immediately repaid. This is either done to reduce interest cost or to remove an onerous restrictive covenant. The bonds most likely to be refunded are those with the highest interest rates (to be replaced by lower interest rate bonds) and low call premiums (so it will not be too expensive to the issuer to call in the debt for refunding).

Which ratio test is used to analyze a revenue bond?
Correct Answer
A. Debt service coverage ratio
B. Collection ratio
C. Debt per capita
Incorrect Answer
D. Debt to assessed valuation

The best answer is A. The debt service coverage ratio applies to revenue bonds. This ratio gives us the pledged revenues of the municipality and divides this by the debt service requirement. Pledged revenues are those pledged to pay debt service and any other requirements set in the bond contract. The bondholder has a lien on these revenues. The higher this ratio, the safer a revenue bond, since there is a greater ratio of revenues to cover debt service. The other ratios are used to analyze G.O. issues.

All of the following statements are true regarding Eurodollar bonds EXCEPT Eurodollar:
A. bond payments are subject to U.S. withholding taxes
B. bonds are issued outside the United States
Incorrect Answer
C. bonds are issued in bearer form
D. bonds pay interest and repay principal in U.S. Dollars

The best answer is A. Eurodollar bond issues are issued in bearer form and are sold overseas (in Europe), but pay in U.S. Dollars. They are not issued in the U.S. and are not subject to U.S. withholding taxes.

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:
Correct Answer
A. $1,350
B. $1,395
C. $13,350
Incorrect Answer
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.

The bondholder of a municipal bond issue is the:
A. borrower of the bond proceeds
Correct Answer
B. lender of the bond proceeds
C. guarantor of the payment of debt service on the bond issue
Incorrect Answer
D. fiduciary acting for the benefit of the bondholders

The best answer is B. The “bondholder” of a bond issue is the party that is owed the debt service on the bonds. This is the “legal” name for the lender or creditor.

A 30 year $1,000 par 4 3/4% Treasury Bond is quoted at 95-11 – 95-15. The note pays interest on Jan 1st and Jul 1st. A customer buys 1 bond at the ask price. What is the current yield, disregarding commissions?
Incorrect Answer
A. 4.68%
B. 4.75%
Correct Answer
C. 4.98%
D. 5.12%

The best answer is C. The bond is purchased at 95 and 15/32nds = 95.46875% of $1,000 = $954.6875. The formula for current yield is:

$47.50
$954.6875 = 4.98%

Banker’s Acceptances are:
I time drafts
II demand deposits
III used to finance imports and exports
IV used to finance the issuance of ADRs
Correct Answer
A. I and III
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is A. Banker’s Acceptances are time drafts on a bank used to finance imports and exports. BAs trade at a discount to their face amount until maturity, but the trading market is rather thin.

Eurodollars are:
I European currency deposits
II U.S. dollar deposits
III held in foreign branches of U.S. banks
IV held in U.S. branches of foreign banks
Incorrect Answer
A. I and III
B. I and IV
Correct Answer
C. II and III
D. II and IV

The best answer is C. Eurodollars are U.S. dollar deposits held in foreign branches of U.S. banks or foreign banks. Eurodollar deposits are used to finance international trade.

A municipal bond that has a put option is protected against depreciation due to:
I rising interest rates
II falling interest rates
III rising demand for the issue
IV falling demand for the issue
A. I and III
Correct Answer
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is B. A bond with a put option allows the holder to put back the bond to the issuer at par value. Thus, this bond, once the put option is exercisable, is always worth at least par. Therefore, if interest rates rise or if market demand falls, this bond’s price cannot fall below par (unlike traditional bonds).

Treasury notes:
I are issued in minimum $100 denominations
II are issued in minimum $10,000 denominations
III mature at par
IV mature at par plus accrued interest
Correct Answer
A. I and III
B. I and IV
C. II and III
Incorrect Answer
D. II and IV

The best answer is A. Treasury notes are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par.

Which of the following statements are TRUE regarding repurchase agreements?
I Repurchase agreements are used by dealers to reduce the carrying cost of Government securities held in their inventory
II Repurchase agreements are initiated by the Federal Reserve to loosen the money supply
III If a repurchase agreement specifies a date and price at which time the trade will be reversed, the agreement is known as a “Reverse” repurchase agreement
IV If a repurchase agreement extends for longer than overnight, the agreement is known as a “Due Bill” repurchase agreement
Correct Answer
A. I and II only
B. III and IV only
C. II and IV only
Incorrect Answer
D. I, II, III, IV

The best answer is A. Under a “repurchase agreement,” a government securities dealer sells some of its inventory to another dealer or to the Federal Reserve, with an agreement to buy back the securities at a later date for a pre-established price. In this manner, the dealer gets a temporary inflow of cash. Since government dealers finance their inventory, by reducing the amount of inventory on hand, they are reducing inventory finance charges when such an agreement is employed. Thus, Choices I and II are true. Choice III is false. Under a “reverse repurchase agreement,” the dealer is buying securities from the Federal Reserve (instead of selling), draining the dealer of cash. Choice IV is also false. Under any repurchase agreement, the underlying government securities are the collateral. The collateral that underlies the agreement must be transferred from seller to buyer to support the transaction. In the “good old days,” dealers could do repurchase agreements that were backed by a promise to deliver the underlying securities (a “due bill” for the securities) instead of making physical delivery. Due bill repurchase agreements are no longer permitted

Which of the following statements are TRUE about the activities of municipal securities brokers’ brokers?
I The use of municipal brokers’ brokers allows financial institutions to maintain anonymity when buying or selling municipal securities
II Any quotes offered by municipal brokers’ brokers must be “bona-fide”
III Municipal brokers’ brokers are required to disseminate their bids and offers through Bloomberg
IV Fees charged by municipal broker’s brokers are established by the Municipal Securities Rulemaking Board
A. I only
Correct Answer
B. I and II
C. III and IV
Incorrect Answer
D. I, II, III, IV

The best answer is B. Municipal brokers’ brokers handle large block trades of municipal securities for institutions such as banks. These middlemen perform the trades without disclosing the identity of the bank – which helps the bank acquire or dispose of large blocks without alerting the market as to its activities. Municipal broker’s brokers perform this very specialized service (there are only about 12 such firms in the U.S.) on an agency basis only – they do not carry inventory positions. As with all municipal traders, they are subject to MSRB rules – therefore all quotes disseminated by brokers’ brokers must be bona-fide. There is no requirement that their quotes be disseminated through quote providers such as Bloomberg or Reuters. The broker’s broker may publish its quotes in Bloomberg or can simply phone other firms to attempt trades. The MSRB does not establish or regulate fees – the MSRB requirement is simply that charges be “fair and reasonable.”

Which of the following would be considered when evaluating the credit risk of a municipal revenue bond?
I Management experience
II The effect of competing facilities
III Coverage ratios
IV Collection ratios
A. I and II only
Incorrect Answer
B. III and IV only
Correct Answer
C. I, II, III
D. I, II, III, IV
A municipal bond dealer buys 100M of 30 year non-callable 9% General Obligation bonds at par less 1 1/2 points. After holding the bonds in inventory for a week, the dealer reoffers the bonds on an 8.90 basis. The dealer’s approximate profit or loss per bond on this transaction is:
A. loss of $11
B. loss of $26
C. gain of $10
Correct
D. gain of $26

The dealer purchases these bonds at par less 1 1/2 points, so the bonds were purchased at 98.5. Since these 9% coupon bonds were reoffered on an 8.90 basis, they must have been reoffered at a premium price. Since these are long term bonds (30 years), we can approximate the reoffering price by dividing 9% (nominal yield) by the 8.90 reoffering yield.

9.00/8.90 = 1.011. Thus, the bonds were reoffered at an approximate price of 1.011% of par (note, this only works for long term maturities – not short term maturities). The bonds were reoffered at a price that is .026% higher than the cost to the dealer (.985 cost versus 1.011 reoffer price). .026% x $100,000 face amount = $26 gain on the transaction.

(Note that “100M” of bonds is $100,000 face amount, where M = $1,000.)

Generally, which statement is FALSE about market index linked CDs?
A. There can be a penalty applied to the principal amount of early withdrawals of funds
Incorrect Answer
B. The annual rate of return may be capped to an amount that is lower than the actual index return
Correct Answer
C. A market index linked CD can be redeemed at any time
D. A market index linked CD is FDIC insured

The best answer is C. Market Index Linked CDs are a type of “structured product” that consists of a “zero-coupon” synthetic bond component that grows based on the returns of an equity index; and that has a maturity established by an embedded option, typically 3 years from issuance.

Market Index Linked Certificates of Deposit tie their investment return to an equity index, usually the Standard and Poor’s 500 Index. This can give a potentially better rate of return than that of a traditional CD. If held to maturity, there is no penalty imposed on any CD. For an early withdrawal, traditional CDs may reduce the interest earned, but there is no loss of principal. In contrast, market index linked CDs typically impose a 3-5% principal penalty for early withdrawal. This “early withdrawal” penalty is imposed because the embedded option that established the maturity of the instrument was paid for and now is not being used.
Both regular and market index linked CDs qualify for FDIC insurance. Finally, the minimum life for market index linked CDs is typically 3 years; whereas traditional bank CDs can have lives as short as 3 months.

A customer holds a very large, diversified portfolio of high grade municipal bonds with varying maturities. This customer has minimized which of the following risks?
I Default risk
II Legislative risk
III Marketability risk
IV Interest rate risk
A. I only
B. III and IV only
Correct
C. I, III, IV
D. I, II, III, IV

The best answer is C. Legislative risk for holders of municipal issues is the risk that the Federal Government will tax the interest income on the bonds. This risk cannot be diversified away. All the other risks can be diversified away. Default risk is minimized with a diversified portfolio; interest rate risk is minimized by mixing maturities. Marketability risk is also reduced by diversification, since it is unlikely that all the issues in the portfolio would become unmarketable at one time.

A municipal “workable” quote is a:
A. firm offer
B. firm bid
Correct Answer
C. indication of a likely bid
Incorrect Answer
D. indication of a likely offer

The best answer is C. A municipal “workable quote” is used to get an indication of a likely price at which a dealer will buy specified bonds. The municipal trading market is very thin, so quotes are not readily available for all bonds. Assume that a customer wants to sell certain municipal bonds and wants to know what price he can get. By calling other dealers, you can get a “workable” from each of the dealers giving a likely price at which they would buy. Now you can go back to the customer with a likely price at which the bonds would be bought. If the customer agrees, you can recall the dealer with the best “workable” and sell the bonds.

A municipal dealer quotes a 9 year, 6% term revenue bond at 109. The yield to maturity is:
A. 4.58
Correct Answer
B. 4.78
Incorrect Answer
C. 5.50
D. 6.00%

The best answer is B. The formula for yield to maturity for a premium bond is:

$60 – ($90 premium / 9 years to maturity)
($1,090 + $1,000) / 2 = $60 – $10
$1,045 =
$50
$1,045 = 4.78%

The final responsibility for the debt service on industrial revenue bonds rests with the:
Incorrect Answer
A. issuing municipality
Correct Answer
B. corporate lessee of the facility
C. bond trustee
D. bond underwriter

The best answer is B. Industrial development bonds are backed by the rental revenues paid by the corporate lessee as well as by the guarantee of the corporate lessee. These bonds, therefore, take on the credit rating of the corporation leasing the facility.

The highest speculative grade rating is:
Incorrect Answer
A. BBB
Correct Answer
B. BB
C. B
D. CCC
The best answer is B. The highest speculative bond rating is BB or Ba. Any rating above that would be considered investment grade.
All of the following should be considered when constructing a diversified municipal bond portfolio EXCEPT:
Incorrect Answer
A. geographical location of the issuers
B. revenue sources backing each issue
C. credit ratings of each issue
Correct Answer
D. denomination of bonds in the portfolio

The best answer is D. When constructing a diversified municipal bond portfolio, one is trying to diversify away as much risk as possible. It would be logical to make sure that the portfolio is geographically diversified since having too great a concentration in one state or region is unwise if the local economy goes bad. A mix of credit ratings also helps to diversify the portfolio. Lower credit rated bonds give higher yields and make sense in a large portfolio, as long as the concentration is not too great. A mix of revenue sources also helps diversify away risk. The denominations of the bonds in the portfolio have no bearing on the risks inherent in those bonds.

The flow of funds set forth in a revenue bond Trust Indenture details the:
A. dates on which bondholders will be paid interest and principal on the issue
B. dates and prices on which the issue can be called by the issuer
Correct Answer
C. priority of collecting and disbursing pledged revenues
Incorrect Answer
D. priority of the bondholder’s claim to the assets of the issuer

The best answer is C. The trust indenture for a revenue bond issue will contain the flow of funds. The flow of funds details the priority of collecting and disbursing pledged revenues.