Reading 63: Overview of Bond Sectors and Instruments-LOS g 习 2011, concerning, statements, following, between

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Session 15: Fixed Income: Basic Concepts
Reading 63: Overview of Bond Sectors and Instruments

LOS g: Describe the types of securities issued by municipalities in the United States and distinguish between tax-backed debt and revenue bonds.

 

 

Which of the following statements concerning municipal securities is NOT correct?

A) Investors may be taxed on any capital gains on municipal securities.

B) A moral obligation bond has no legally binding requirement to be repaid.

C) All interest on municipal securities is tax-exempt at the federal level.

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Some interest on municipal bonds, such as municipal bond issues to build stadiums/arenas, is taxable at the federal level. Note though that most municipal bonds are tax-exempt – taxable munis tend to be the exception rather than the rule.

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Which of the following statements about fixed income securities is least accurate?

A) The main innovation of CMO is that they offer stable maturities to investors.

B) The corporate bond sector is more important in the US than in Japan and Germany.

C) Coupon interest and capital gains from municipal bonds are tax exempt at the federal level.

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Coupon or interest income is exempt from federal income taxes. Capital gains taxes associated with municipal bonds are not exempt from federal taxes.

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Which of the following statements concerning municipal bonds is NOT correct?

A) Before-tax yields on municipal bonds are usually lower than before-tax yields on Treasury bonds.

B) The vast majority of municipal bonds sell at lower yields because their bond interest is exempt from federal income tax.

C) Municipal bonds have lower risk than Treasury bonds because of their lower yield.

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Treasury bonds are considered default free and have the least amount of risk. After-tax yields are highest for individuals in the highest tax bracket who benefit the most from the municipal bond’s tax-exempt status. Before tax yields on municipal bonds are lower due to their tax shield.

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Which of the following statements about municipal bonds is least accurate?

A) A municipal bond guarantee is a form of insurance provided by a third party other than the issuer.

B) Revenue bonds have lower yields than general obligation bonds because there are more revenue bands and they have higher liquidity.

C) Bonds with municipal bond guarantees are more liquid in the secondary market and generally have lower required yields.

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General obligation bonds are backed by the full faith, credit, and taxing power of the issuer.

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Support for the revenue bonds comes from:

A) the gross revenues of the underlying project.

B) the net revenues of the underlying project.

C) property taxes based on the project.

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Revenue bonds are serviced by the net income generated from specific income-producing projects (e.g., toll roads).

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Which statement about the risks of bond investing is least accurate?

A) Interest on some municipal bonds is not excluded from federal income taxes.

B) Bankruptcy courts do not always follow the absolute priority rule.

C) In a competitive Treasury-bill auction, not all bidders pay the same price.

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All T-bills are auctioned using the single-price method, in which all-successful bidders pay the price implied by the stop yield, which is the yield at which the quality demanded equals the quantity for sale. Bankruptcy courts follow the absolute priority rule when possible, but not always. Most municipal bonds are exempt from federal taxes, but not all of them.

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The most junior type of municipal bond is the:

A) indenture bond.

B) income or revenue bond.

C) general obligation bond.

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General obligation bonds are backed by the full faith, credit, and taxing power of the issuer. Revenue bonds are serviced by the income generated from specific income-producing projects and can not be paid from other proceeds unrelated to the project.

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Consider three municipal bonds issued by the Greater Holmen Metropolitan Capital Improvement District, a local authority that carries an issuer rating of single-A from the major debt rating agencies. All three bonds have the same coupon rate and maturity date.

• Series W was issued to finance the rebuilding and expansion of local schools and is backed by the District’s authority to levy property tax.
• Series X was issued to build a water purification plant for the region. The District charges fees to the surrounding municipalities for their use of the plant. These fees are the only source of the interest and principal payments on the bonds.
• Series Y was issued to raise funds for the general use of the District in its ordinary maintenance projects and is backed by the District’s authority to levy property tax. These bonds carry a third party guarantee of principal and interest payments.
  

What is most likely the order of the market yields on these three bond issues, from highest to lowest?

A) Series Y, Series W, Series X.

B) Series X, Series W, Series Y.

C) Series X, Series Y, Series W.

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Series X is a revenue bond. Because they pay interest and principal only if revenues from the project they finance are sufficient, revenue bonds are typically riskier and therefore have higher market yields than general obligation bonds. Series Y is an insured bond. Municipal bond insurance typically results in a higher rating, and therefore a lower market yield, than an equivalent bond from the same municipal issuer. So of these three bonds, Series X should have the highest market yield and Series Y the lowest.

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Which of the following statements about U.S. debt securities is most accurate?

A) Government agency issues are backed by the full faith and credit of the Treasury.

B) Municipal bond guarantees apply to principal but not interest payments in the event of default.

C) General obligation bonds are backed by the full faith and credit of the issuer.

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One type of issuer of federal agency securities is government sponsored enterprises (GSE). GSE securities are not backed by the full faith and credit of the Treasury. Municipal bond guarantees may apply to both principal and interest guarantees.