Ch. 2, Corp and Municipal Debt Securities | Day 5 Flashcards
(20 cards)
What is a General Obligation Bond and what does it require for issuance?
A General Obligation Bond is a municipal bond backed by the taxing power of the issuing state or local government. Its issuance requires voter approval and must comply with statutory debt limits.
How are property taxes related to general obligation bonds?
Property taxes support general obligation bonds at the local level. Taxes are based on assessed value, not market value, and municipalities use assessments to determine tax revenue for bond repayment.
What is overlapping debt and how does it affect taxpayers?
Overlapping debt occurs when multiple municipal authorities issue debt drawing from the same taxpayer base, causing taxpayers to be liable for multiple sources of municipal debt (e.g., town and county).
What are revenue bonds and how are they repaid?
Revenue bonds are municipal bonds repaid from income generated by a specific project (e.g., toll roads or utilities). They do not rely on tax revenue but must include an indenture with covenants and legal provisions.
Name three covenants typically found in a revenue bond indenture.
Common covenants include the rate covenant, maintenance covenant, and insurance covenant. These legally bind the issuer to conditions that protect bondholders.
What distinguishes an industrial development/revenue bond from other municipal bonds?
Issued for the benefit of private corporations, these bonds are backed by lease payments made by the corporation to the municipality. They may trigger AMT liability for high-income investors.
What is a lease rental bond and how does it function?
It’s a municipal bond issued to finance a facility that is then leased to an agency (e.g., school district). Lease payments are used to service the debt.
Define a special tax bond and provide examples of tax sources that may support it.
A special tax bond is backed by revenues from specific taxes such as alcohol, tobacco, gasoline, or hotel taxes. These are revenue bonds, not general obligation bonds.
What are special assessment bonds and who pays for them?
They finance projects benefiting a specific geographic area (e.g., sidewalks or reservoirs). Homeowners in the benefiting area are taxed to repay the bonds, while others are exempt.
What is a double-barreled bond and what makes it unique?
These bonds are initially supported by facility revenue (like a toll), but if that revenue is insufficient, general tax revenues of the issuer also back the bond. They trade like general obligation bonds.
Explain a moral obligation bond and how the state might handle shortfalls.
This bond is backed by project revenues, but the state legislature may opt to cover shortfalls with tax revenues. There is no legal requirement for the state to do so.
How do NHA/PHA bonds differ from other municipal bonds?
Issued for low-income housing, their debt service is covered by tenant rent. If rent is insufficient, the U.S. government covers shortfalls, making them the safest type of municipal bond.
What are short-term municipal notes and what rating system is used?
These notes (e.g., TANs, RANs, BANs, TRANs) provide temporary funding. They are rated by Moody’s MIG scale from MIG 1 (best) to MIG 4 (worst).
What does the doctrine of reciprocal immunity state regarding municipal bond interest?
It states that interest earned on municipal securities is exempt from federal income tax and vice versa for federal securities at the state level—though repealed, it still protects municipal interest from federal taxation.
What is the tax-equivalent yield and how is it calculated?
It determines the equivalent yield of a tax-free bond compared to a taxable one:
Formula:
Tax-equivalent yield = Tax-free yield / (1 − Investor’s tax bracket)
Provide an example calculation of tax-equivalent yield for a 30% tax bracket and a 7% municipal bond.
Tax-equivalent yield = 7% / (1 − 0.30) = 7% / 0.70 = 10%
What are the tax benefits of purchasing a municipal bond in the investor’s home state?
Interest is exempt from federal, state, and local income taxes if the bond is issued within the investor’s state of residence.
What does “triple tax free” mean in the context of municipal bonds?
It refers to bonds from U.S. territories like Puerto Rico or Guam, where interest is exempt from federal, state, and local taxes.
What are some of the key features that must be included in a revenue bond indenture?
Key features include catastrophe clauses, rate covenants, flow of funds, call/put features, maintenance covenants, and a sinking fund.
Why might industrial development bonds be less attractive to high-income investors?
Because their interest may be subject to the Alternative Minimum Tax (AMT), reducing the tax advantage for high-income individuals.
