Chapter 2.5

Question 1

Agent

Answer 1

Trade on exchanges. The capacity is agents charging a commission.

Question 2

Principal

Answer 2

Trade Over the Counter(OTC). The capacity is a dealer charging a mark-up or a mark-down.

Question 3

Secondary Market for municipal bonds

Answer 3

The market for municipal bonds after they have been originally sold by the underwriters on the public offering. Almost every trade will be handled on a principal basis rather than through an agency trade. Functions of the secondary market include:

• The purchase and sale of bonds dealer to dealer
• The maintenance of markets for dollar bonds(bonds quoted in dollars, rather than yield)
• The maintenance of markets for bonds that are in default.

**The purchase of a new issue is not a function of the secondary market.

Question 4

A quotation given by a municipal securities dealer:

Answer 4

• Must be “bona fide” meaning the security can be bought or sold as state in the quotation
• May be subject to prior purchase or sale
• May be subject to a subsequent price change
• May be nominal - for information only.
• May be made on behalf of another B/D
• Is deemed published if it is disseminated by:
  
  • Bloomberg, Municenter
  • Telephone
  • Offering sheets
  • Or any means of communication
• A quotation is not considered to be an Ad
• Sending out an official statement would not be considered to be giving a quote
• A quotation given by one or more municipal dealer does not necessarily represent the best bid or offer prevailing in the marketplace.
  
  • A municipal dealer cannot state that they are offering bonds “at the market” if they are the only dealer offering the bonds.
• Secondary market municipal bond transactions must be reported within 15 minutes of execution.
• A quotation given by a municipal dealer, if for a dealer joint account, cannot distribute quotes that would indicate multiple markets.

Question 5

What must a b/d consider when determining a “fair and reasonable” price on a principal transaction?

Answer 5

• The fair market value of the securities at the time of the transaction
• Any other securities traded in connection with the transaction
• The expense involved in effecting the transaction
• That the dealer is entitled to a profit
• The total dollar amount of the transaction

Question 6

What must a b/d consider when determining a “fair and reasonable” commission on an agency transaction(commission)?

Answer 6

• The availability of the security
• The expense of executing the customer’s order
• The value of services rendered in connection with the transaction
• The amount of any other compensation received or to be received in connection with the transaction.

**The MSRB does not set commission rates, mark-up or mark-down rates. The MSRB requires charges to be “Fair and reasonable”.

Question 7

What must a broker confirm and keep a record of in a municipal agency order?

Answer 7

• The name of the person entering the order
• Date and time of receipt of the order
• Price and time of execution
• Terms and conditions of the transaction
• The source and amount of any remuneration
• *If a municipal transaction is cancelled, the firm must keep a record of the cancellation date, time of cancellation, and the name of the principal approving the cancellation.
• *It is a violation of rule G-14 if there is a failure to report on an agency transaction which also results in an incomplete audit record.
• *The name of the registered rep who received the order is not required on the order ticket.

Question 8

When acting on behalf of a customer as agent or when acting as broker’s broker, a reasonable effort to obtain what must be sought?

Answer 8

A fair and reasonable price to the prevailing market. No b/d or agent shall charge a commission that is in excess of a fair and reasonable amount.

Question 9

Anti-fraud Provisions

Answer 9

Apply to all persons

Question 10

Omission of material facts

Answer 10

Is a violation of the anti-fraud provisions.

Question 11

Refunding Bonds

Answer 11

Bonds issued by a municipality, the purpose of which is to pay off existing bonds. The municipality calls in or retires the old bonds with monies generated from the sale of new bonds. The 3 primary reasons for refunding include:

• To lower interest costs
• To change the maturity or amortization schedule of the bonds
• To liberalize the bond’s indenture provisions

Question 12

If a customer cancels a transaction with a B/D, the firm must keep a record of:

Answer 12

• The cancellation date
• The time of cancellation and
• A record of the principal approving the cancellation

Question 13

Pre-refunding and Advance Refunding Bonds

Answer 13

The municipality issues new bonds whose proceeds will be used in the future to pay off existing bonds. The proceeds of the new bond issue are invested in U.S. government securities. The principal and interest invested in government securities is pledged exclusively to the payment of principal and interest of the existing issue. This pledge eliminates(defeases) the old bond issue as part of the municipality debt limit.

• Pre-refunding: The original issue will be redeemed on the earliest call date. Pre-refunding can only be done within 90 days of the call date and can also be referred to as a “current” refund.
• Advance refunding: The bonds are generally non-callable and are redeemed at the original maturity date.
• *Pre-refunding and advance refunding improves the quality rating of the original issue since the bonds are then backed by U.S. Government Securities.
• *IRS rules prohibit the issuer of tax exempt refunding bonds from earning the difference between what they are paying out on municipal bonds versus what they are receiving on the treasuries they invest in.
• Yield Burning: When the price of the government bonds purchased in advance refunding is marked-up to lower the yield on the government bonds to avoid the arbitrage profits and tax liability.

Question 14

A round lot in the Municipal bond market represents how much money?

Answer 14

$100,000

Question 15

Pricing Callable Bond Issues:

Answer 15

• If the bonds are trading at a discount, the bonds will be priced to maturity.
• If the bonds are trading at a premium, the bonds must be priced to the lesser of the price to call or to maturity.

Question 16

Disclosure scenario: Variable rate demand obligations

Answer 16

A description of the basis on which periodic interest rate resets are determined and the role of the remarketing agent.

Question 17

Disclosure scenario: Auction rate securities

Answer 17

Features of the auction process that would be considered significant by a reasonable investor and the basis on which periodic interest rate resets are determined.

Question 18

Disclosure scenario: Credit risks and ratings

Answer 18

The credit rating or lack thereof, credit rating changes, credit risk of the municipal security, and any underlying credit rating or lack thereof.

Question 19

Disclosure scenario: Credit or liquidity enhanced securities

Answer 19

The identity of any credit enhancer or liquidity provider, terms or the credit facility or liquidity facility, and the credit rating of the credit provider or liquidity provider, including potential rating actions.

Question 20

Disclosure scenario: Insured Securities

Answer 20

The fact that a security has been insured or arrangements for insurance have been initiated, the credit rating of the insurance company, and information about potential rating actions with respect to the bond insurance company.

Question 21

Disclosure scenario: Original issue discount bonds

Answer 21

The fact that a security bears an original issue discount since it may affect the tax treatment of a municipal security.

Question 22

Disclosure scenario: Securities sold below the minimum denomination

Answer 22

The fact that a sale of a quantity of municipal securities is below the minimum denomination authorized by the bond documents and the potential adverse effect on liquidity of a customer positions below the minimum denomination.

Question 23

Disclosure scenario: Securities with non-standard features

Answer 23

Any non-standard feature of a municipal security.

Question 24

Disclosure scenario: Bonds that prepay principal

Answer 24

The fact that the security prepays principal and the amount of unpaid principal that will be delivered on the transaction

Question 25

Disclosure scenario: Callable securities

Answer 25

The fact that a municipal security may be redeemed prior to maturity in-whole, in-part, or in extraordinary circumstances.

Question 26

Disclosure scenario: Put option and tender option bonds

Answer 26

Information concerning the put option or tender option features

Question 27

Disclosure scenario: Stripped coupon securities

Answer 27

Facts concerning the underlying securities which materially affect the stripped coupon instruments. The unusual nature of these securities and their tax treatment warrants special efforts to provide written disclosures.

Question 28

Disclosure scenario: The investment of bond proceeds

Answer 28

Information on the investment of bond proceeds

Question 29

Disclosure scenario: Issuer's intent to pre-refund

Answer 29

An issuer's intent to pre-refund an issue

Question 30

Disclosure scenario: Failure to make continuing disclosure filings

Answer 30

Discovery that an issuer has failed to make filings required under it's continuing disclosure agreements

Question 31

MSRB Rule G-14 - Reports of Sales or Purchases

Answer 31

- Each broker, dealer, or municipal securities dealer shall report to the board information about each purchase and sale transaction effected in municipal securities to the Real-time transaction reporting system. - Each dealer shall provide to the board on form RTRS information including: - The manner in which transactions will be reported - The broker symbol used by the dealer - The identity of and any information on any intermediary to be used as a submitter - Information on Personnel that can be contacted if there are problems in RTRS submissions.

Question 32

When must B/D's file form RTRS?

Answer 32

- The general rule states that B/D's must file form RTRS within 15 minutes of the execution of a transaction to the national securities clearing corporation. - Exceptions: Syndicate managers, syndicate members, and selling group members that effect trades in new issues with customers on the first day of trading at the list offering price/takedown shall report such trades by the end of the day on which the trades were executed(after the first day, trades must be reported within 15 minutes of execution of the transaction). - A dealer shall report a trade within 3 hours of the time of trade if all the following conditions apply: - The CUSIP number and indicative data of the issue traded are not in the securities master file used by the dealer to process trades for confirmations, clearance and settlement. - The dealer has not traded the issue in the previous year - The dealer is not a syndicate manager or syndicate member for the issue - The following transactions shall not be reported under RTRS: - Transactions in securities without assigned CUSIP numbers - Transactions in Municipal Fund Securities; and - Inter-dealer transactions for principal movement of securities between dealers that are not inter-dealer transactions eligible for comparison in a clearing agency registered with the commission.

Question 33

When can auction rate securities, commercial paper, and variable rate securities transactions be reported?

Answer 33

As late as the end of the trade date.

Question 34

Transactions effected outside of the RTRS Business Day

Answer 34

Shall be reported no later than 15 minutes after the beginning of the next valid RTRS Business day and shall report the trade date of submission and earliest "valid time"

Question 35

Real time transaction matching

Answer 35

Transaction reversals must be reported according to RTTM procedures for audit trail purposes with a reversal control number.

Question 36

Transaction data that is not submitted in a timely manner according to RTRS providers must be submitted when?

Answer 36

As soon as possible.

Question 37

Transactions with Issuers

Answer 37

Do not have to be reported through RTRS

Question 38

Federal Income tax treatment of Municipal Bond Premiums

Answer 38

Must be amortized over the life of the bond. This results in an "amortized"(reduced) cost basis for tax purposes. The account method is known as "straight line method" amortization. - When a municipal bond is purchased at a premium and - Held to maturity: There will be no tax liability(no gain or loss). - Sold prior to maturity: You would reduce the cost basis by the amount that has been amortized(written off).

Question 39

Federal Income tax treatment of Municipal Bond Discounts

Answer 39

- Original Issue Discount: If the investor buys the bond at a discount on an original offering, they can treat the discount as part of the interest income received, and not as a capital gain. This is in the investor's favor, because all interest income is tax-free. - Secondary market Discount: When the bonds are bought at a discount in the secondary market, the discount would be treated as Ordinary income(fully taxable) to the investor.

Question 40

Broker/Dealers that receive "Official Communications" from an issuer and the issuer requests that the communications be forwarded to beneficial owners when such securities are held in safekeeping by the member, may use reasonable efforts to transmit such communication to the parties if the member is offered adequate compensation and sufficient copies of the communication are provided:

Answer 40

- Copies may be sent to investment advisors - Copies do not have to be sent to owners not residing in the U.S. - If the client has given written authorization, the member firm may provide the customer's information to the issuer.

Question 41

What is the most important factor in determining if the customer received a "fair and reasonable price"?

Answer 41

The resulting yield to the customer based on yields of comparable securities in the marketplace.

Question 42

When can a firm use information obtained from an issuer? For example, a list of bondholders.

Answer 42

Only with the issuers' permission.

Question 43

Cover or Cover Bid

Answer 43

The difference between the winning bid on a new issue or secondary market transaction and the next best bid. **It is illegal to submit false cover bids in order to manipulate the price of a bond.

Question 44

Accrued Interest on municipal bond trades

Answer 44

Calculated on a 30-day month, 360-day year and is paid up to but not including the settlement date or interest pay date. Accrued interest is: - Always less than full coupon - Always added to the purchase price of the bond - Always added to the amount seller receives

Question 45

Outstanding callable bonds

Answer 45

It would be a violation if a municipal dealer that is authorized to help an issuer determine which outstanding callable bonds should be called in and the dealer intentionally excludes their own firm's proprietary positions.

Question 46

Municipal Note schedule

Answer 46

Uses a 365 day year and the actual number of days in a month.