Evaluate Municipal Securities - Series 7

1. Which type of municipal bond can create taxable interest for some investors under AMT rules?

   Private activity bond (PAB). Private activity bonds may trigger AMT liability due to their support of private entities, affecting high-income investors.

2. What is the formula for tax-equivalent yield (TEY) using a marginal tax rate $t$?

   $TEY=\frac{\text{municipal yield}}{1-t}$. The TEY formula converts tax-free yields to taxable equivalents, aiding comparison across investments at given tax rates.

3. What is an overlapping debt analysis used to evaluate for municipal issuers?

   Total direct plus shared debt burden on the same tax base. Overlapping debt evaluates the total obligations across jurisdictions to assess the full burden on shared taxpayers.

4. What is a debt service reserve fund (DSRF) for a revenue bond intended to do?

   Provide backup funds to pay debt service if revenues fall short. The DSRF provides a cushion equivalent to one year's debt service to cover temporary revenue deficiencies.

5. What is a special assessment municipal bond primarily secured by?

   Assessments levied on benefited properties, not general taxes. Special assessments target properties benefiting from improvements, limiting repayment risk to those specific assets.

6. What is a tax anticipation note (TAN) and what is its repayment source?

   Short-term note repaid from expected tax collections. TANs address cash flow timing mismatches by borrowing against assured future tax revenues for short-term needs.

7. Which bond type is typically backed by the full faith and credit of the issuer: GO or revenue?

   GO bond. General obligation bonds pledge the issuer's full faith, credit, and taxing power, providing broader security than revenue bonds.

8. Identify the tax-equivalent yield if a muni yields $4\%$ and the marginal tax rate is $40\%$.

   $6.67\%$. The TEY calculation adjusts the tax-exempt yield upward to reflect equivalent taxable return at the 40% rate.

9. What is a moral obligation bond?

   A bond supported by a nonbinding pledge to consider appropriations. Moral obligation bonds carry an implied but non-legal commitment from the issuer to replenish reserves if needed.

10. What is a bond anticipation note (BAN) and what is its repayment source?

    Short-term note repaid from proceeds of a future bond issue. BANs enable project initiation with repayment from subsequent long-term bond sales, managing issuance timing.

11. What is the tax status of interest on a taxable municipal bond (for example, Build America Bonds)?

    Interest is subject to federal income tax. Taxable municipals like Build America Bonds lack federal exemption to broaden investor appeal with higher yields.

12. Which option is more suitable at a $37\%$ tax rate: $4\%$ muni or $6\%$ corporate (ignore state tax)?

    The $4\%$ muni. At a 37% tax rate, the municipal's tax-exempt status yields a higher effective return than the taxable corporate bond.

13. What does a revenue bond "rate covenant" require?

    Issuer must set fees/rates to produce sufficient revenues. The rate covenant mandates sufficient user fees to meet operating costs and debt obligations, protecting bondholders.

14. What is the typical tax status of interest on municipal bonds at the federal level?

    Generally exempt from federal income tax. Federal tax exemption on municipal interest lowers borrowing costs for issuers by attracting investors seeking tax advantages.

15. What is meant by "flow of funds" in a revenue bond indenture?

    Priority order for applying revenues to O&M, debt service, reserves. Flow of funds specifies the sequential use of revenues, ensuring operations are funded before debt and reserves.

16. What is the key credit analysis focus for a revenue bond?

    Feasibility and cash flow coverage of pledged revenues. Revenue bond credit focuses on project viability and revenue adequacy to cover debt service without tax backing.

17. What is a double-barreled municipal bond?

    A revenue bond with a GO (tax) pledge as secondary support. Double-barreled bonds enhance credit by combining primary revenue pledges with secondary general obligation support from taxes.

18. What is the primary source of repayment for a general obligation (GO) municipal bond?

    Issuer's taxing power, typically ad valorem property taxes. General obligation bonds are secured by the issuer's full faith, credit, and unlimited taxing authority to ensure repayment.

19. What is the general state and local tax rule for in-state municipal bond interest?

    Often exempt from state and local tax in the issuer's state. In-state exemptions encourage local investment and reduce effective yields for residents compared to out-of-state bonds.

20. What is the primary source of repayment for a municipal revenue bond?

    Revenues from a specific project or enterprise. Revenue bonds depend solely on income generated by the financed facility, without recourse to the issuer's taxing power.

21. What does "additional bonds test" (ABT) protect against in a revenue bond indenture?

    Excess issuance of parity debt that could dilute coverage. The additional bonds test limits new parity debt to maintain adequate revenue coverage for existing obligations.

22. What is the key credit analysis focus for a GO municipal bond?

    Tax base and issuer's ability and willingness to levy taxes. Credit analysis for GO bonds emphasizes the strength of the economic base and issuer's fiscal policies to support tax collections.

23. What is a revenue anticipation note (RAN) and what is its repayment source?

    Short-term note repaid from expected non-tax revenues. RANs provide interim financing secured by anticipated non-tax income, such as grants or user fees.

24. What is the main credit risk difference between GO bonds and revenue bonds?

    GO relies on taxing power; revenue relies on project cash flows. GO bonds offer lower risk due to broad tax support, while revenue bonds face higher risk from project-specific revenues.

25. Identify the after-tax yield if a corporate bond yields $6\%$ and the marginal tax rate is $25\%$.

    $4.50\%$. After-tax yield reduces the nominal rate by the tax portion, providing the net return to the investor.

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