160 terms

Chapter 3: Municipal Securities

Municipal bonds
-securities issued either by state or local government or by US territories, authorities, and special districts
-investors loan money to the issuers for the purpose of public works and construction projects
-considered 2nd in safety in safety of principal (to US gov and agency securities)
-exempt from the filing requirements of the Act of 1933
-federally tax exempt on interest payments
-subject to state and local tax
-capital gains are always taxed
-generally pay lower interest rates than do corporate issuers
-*more appropriate for investors in high tax brackets
-maturities of less than one year to 30 years
Securities Exchange Act of 1934
-Municipals are subject to the antifraud provisions
Doctrine of Reciprocal Immunity
-(Doctrine of Mutual Reciprocity) specifies that a level of government can tax only the interest of its own issues
Municipal Issuers
-Territorial possesions of the US
-State governments
-Legally constituted taxing authorities (county and city governments, gov agencies, port authorities/mass transit, and special districts)
Term Maturity
-all principal matures at a single date in the future
-issuers sometimes establish a sinking fund account to accumulate funds to pay off term bonds
-quoted by price called Dollar Bonds
Serial Maturity
-bonds within an issue mature on different dates according to a predetermined schedule.
-quoted on the basis of their yield to maturity (BASIS) to reflect the difference of maturity dates within one issue
-Most bonds are issued Serially
Balloon Maturity
-an issuer pays part of a bond's maturity before the final maturity date, but the largest portion is paid off at maturity
-type of serial bond
General Obligation Bonds (GOs)
-municipal bonds issued for capital improvements that benefit the enture community
-generally these projects do not produce revenues, so principal and interest must be paid by taxes collected by the municipal issuer
-also known as Full Faith and Credit Issues
GO Sources of Funds
-bonds issued by States are back by income taxes, license fees, and sales taxes
-bonds issued by towns, cities, and counties are backed by property (ad valorem) taxes, license fees, fines, and all other sources of revenue to the municipality
-school, road and park districts may also issue municipal bonds backed by property taxes
Statutory Debt Limits
-the amount of debt that a municipal government may incur can be limited by state or local statutes to protect taxpayers from excessive taxes
-make bonds safer for investors
-the lower the debt limit, the less risk of excessive borrowing and default by the municipality
Voter Approval
Statutory Debt Limit
-if an issuer wishes to issue GO bonds that would put it above its statutory limit, a public referendum is required
Tax Limits
Statutory Debt Limit
-some states limit property taxes to a certain percentage of the assessed property value or to a certain percentage increase in any single year.
-tax rate is expressed in mills; one mill = $1 per $1000, or $.001
Limited Tax GO
Statutory Debt Limit
-bond secured by a specific tax (ie income tax)
-the issuer is limited as to what tax or taxes can be used to service the debt
-more risk
Overlapping Debt
Statutory Debt Limit
-ex. town and county debt together
-several taxing authorities that draw from the same taxpayers can issue debt
-*Coterminous Debt: bonds issued by different municipal authorities that tap the same taxpayer wallets or, two or more taxing agencies that share the same geographic boundaries and are able to issue debt separately
-State debt never overlaps
Double-Barreled Bonds
-revenue bonds that have characteristics of GO bonds
-interest and prinicipal are paid from a specified facility's earnings and the taxing power of the state or municipality
-basically have the backing of two sources of revenue
-rated and traded as GOs
Revenue Bonds
-can be used to finance any municipal facility that generates sufficient income
-not subject to statutory debt limits and do not require voter approval
-additional bonds test ensures the adequacy of the revenue stream to pay both the old and new debt
Feasibility Study
-an issuer will engage various consultants to prepare a report detailing the economic feasibility and the need for a particular project
-includes estimates of revenues that will be generated and details of the operating, economic, or engineering aspects of the proposed project
Sources of Revenue
-education (college dorms and student loans)
-health(hospital and retirement centers)
-industrial (industrial development and pollution control)
Trust Indenture (Bond Resolution)
-this empowers the trustee to act on behalf of the bondholders
-the municipality agrees to abide by certain protective covenants, or promises, meant to protect bondholders
-a trustee appointed in the indenture supervises the issuer's compliance with the bond covenants
Rate Covenant
-a promise to maintain rates sufficient to pay expenses and debt service
Maintenance Covenant
-a promise to maintain the equipment and facilities
Insurance Covenant
-a promise to insure any facility built so bondholders can be paid off if the facility is destroyed or becomes inoperable
Additional Bonds Test
-whether the indenture is open-ended (allowing further issuance of bonds with the same status and equal claims on revenue) or closed-ended (allowing no further issuance of bonds with an equivalent lien on earnings; with a closed-end provision, any additional bonds issued will be subordinated to the original issue)
Sinking Fund
-money to pay off interest and principal obligations
Catastrophe clause
-a promise to use insurance proceeds to call bonds and repay bondholders if a facility is destroyed; a catastrophe call is also called a calamity call or an extraordinary mandatory call
Flow of Funds
-the priority of disbursing the revenues collected
Books and Records Covenant
-requires outside audit records and financial reports
Call Features
-part of the bond convenant
Industrial Development Revenue Bonds (IDRs or IDBs)
-issued by a municipal development authority to construct facilities or purchase equipment, which is then leased to a corporation
-the municipality uses the money from lease payments to pay the interest and principal on the bonds
-responsibility of payments lie with the corp leasing the facility
Tax Reform Act of 1986
-the interest on these nonpublic purpose bonds may be taxable because the act reserves tax exemption for public purposes
Lease Rental Bonds
-under a typical lease-rental (lease-back) bond arrangement, a municipality issues bonds to finance office construction for itself or its state or community
Special Tax Bonds
-bonds secured by one or more designated taxes other than ad valorem taxes
-such as sales, tabacco, fuel, or business license taxes
-not considered self-supporting debt
Special Assessment Bonds
-issued to finance the construction of public improvements as such as streets, sidewalks, or sewers
New Housing Authority Bonds (NHAs)
-issued by local housing authorities to develop and improve low-income housing.
-backed by the full faith and credit of the US government
-also called Section 8 bonds
-AAA rated
Public Housing Authority Bonds (PHAs)
-backed by the rental income from the housing
-if the rental income isn't sufficient to cover the debt, the federal government makes up for any shortfall
-AAA rated
-NOT double-barreled bonds
-also called Section 8 bonds
Moral Obligation Bonds
-a state or local issued, or state or local agency issued, bond
-if revenues or tax collections are not sufficient, the state legislation has authority to fill the void
-the potential backing makes the bonds more marketable, but they are not obligated by law to pay the debt
-are Revenue Bonds ONLY
Issuer Default
-if GO bond goes into default, bondholders have the right to sue to compel a tax levy to pay off the bonds
-if a Moral Obligation goes into default, bondholders can only be paid through legislative apportionment (the issuer's legislature would have to apportion money to satisfy the debt but is not legally obligated to do so)
Municipal Anticipation Notes
-short-term securities that generate funds for a municipality that expects other revenues soon
-usually have less than 12 month maturities, but some can range from 3 months to 3 years
-they are repaid when the municipality receives the anticipated funds
Tax Anticipation Notes (TANs)
-finance current operations in anticipation of future tax receipts
-helps muni's to even out cash flow between tax collection periods
Revenue Anticipation Notes (RANs)
-offered periodically to finance current operations in anticipation of future revenues from revenue producing projects or facilities
Tax and Revenue Anticipation Notes (TRANs)
-a combination of the characteristics of both TANs and RANs
Bond Anticipation Notes (BANs)
-sold as interim financing that will eventually be converted long term funding through a sale of bonds
Tax-exempt Commercial Paper
-often used in place of BANs and TANs for up to 270 days, though maturities are often 30, 60 and 90 days
Construction Loan Notes (CLNs)
-issued to provide interim financing for the construction of housing projects
Variable Rate Demand Notes
-have a fluctuating interest rate and are usually issued with a put option
Grant Anticipation Notes (GANs)
-issued with the expectation of receiving grant money from the federal government
Variable Rate Municipal Bond (Reset Bonds)
-offers interest payments tied to the movements of another specified interest rate (like an adjustable rate mortgage)
-price remains relatively stable due to the coupon rate changing with the market
-coupon reset to the market every 6 months
Auction Rate Securities (ARS)
-long-term variable rate bonds tied to short-term interest rates
-maturities of 20 to 30 years
-interest rates determined through a Dutch auction method at predetermined short-term intervals of 7, 28, or 35 days
-auction uses a competitive bid process
-est a Reset Rate or clearing rate
-Are callable at par
-State and Local Government Securities Series
-US gov securities issued directly by the Treasury to municipal issuers only in connection with pre-refundings
Build America Bonds (BABs)
-created under the Economic Recovery and Reinvestment Act of 2009
-assist in reducing costs to issuing municipalities and stimulating the economy
-taxable obligations (interest)
-*attracted investors who would normally not buy tax-exempt muni bonds and expanded the pool of investors to include those in the lower tax brackets, investors funding retirement accounts where tax-free securities would normally not be suitable, public pension funds and foreign investors
-program has expired
Tax Credit or Issuer BABs
-provide no credit to the bondholder but instead provide the municipal issuer with payments from the US Treasury equal to 35% of the interest paid by the issuer
Direct Payment BABs
-provide the bondholder with a federal income tax credit equal to 35% of the interest paid on the bond in each tax year
-excess credit may be carried forward
Bond Contract
-a collection of legal documents that includes a bond resolution or trust indenture, applicable state and federal law, and other legal documents pertaining to that particular issue and issuer
-municipal issuer enters into bond contract with underwriters of, and prospective investors in, its securities
Bond Resolution
-contains a description of the issue
-muni authorizes the issue and sale of its securities through the bond resolution
Protective Covenant
-or underlying trust indenture
-not required by law, but most muni issuers use indentures to make the issue more marketable
-*serves as a contract between the bond's issuer and a trustee appointed on behalf of the bond's investors
Flow of Funds Statement
-*included in the Protective Covenant
-establishes the priority of payments made from a facility's revenues
Official Statement
-must be signed by an officer of the issuer, is the muni securities industry's equivalent of a corporate prospectus
-serves as disclosure document and contains any material information an investor might need about an issue
-prepared by the issuer, it includes:
>offering terms
>summary statement
>purpose of issue
>authorization of bonds
>security of bonds
>description of bonds
>description of issuer, including organization and management, area economy and a financial summary
>construction program
>project feasibility statement
> regulatory matters
>specific provisions of the identure or resolution, including funds and accounts, investment of funds, additional bonds, insurance, and events of default
>legal proceedings
>tax status
>appropriate appendixes, including consultant reports, the legal opinion, and financial statements
>credit enhancements
-*any municipal securities dealer involved in the sale of a new issue must deliver a final official statement to every customer who has purchased the issue, at or before settlement date
Preliminary Official Statement
-discloses everything on the OS except for the issue's interest rates and offering price
-use to determine investors' and dealers' interest in the issue
Legal Opinion
-printed on the face of every bond certificate (except if Ex-Legal)
-written and signed by the Bond Counsel (an attorney specializing in tax-exempt bond offerings)
-states that the issue is legally binding on the issuer and conforms with applicable laws
-tax-exempt interest must also be stated
-entered as either qualified (there may be a legal uncertainty of which purchasers should be informed) or unqualified (issued by the bond counsel unconditionally)
-bond must state Ex-Legal if the issuer chooses not to obtain the legal opinion (will meet good delivery)
Underwriter's Counsel
-managing underwriter may choose to employ another law firm as underwriter's counsel
-not responsible for the legal opinion and is employed to represent the underwriter's interest
Negotiated Underwriting
-the municipality appoints an investment banker to underwrite the offering
-underwriter works with the issuer to establish the interest rate and the offering price in light of the issuer's financial needs and market conditions
-can be distributed as either a public offering or via a prive placement
Competitive Bidding
-a municipality publishes an invitation to bid
-investment bankers respond in writing to the issuer's attorney or other designated official requesting information on the offering
- the bid with the lowest net interest cost to the issuer is the winner in a competitive bid
Official Notice of Sale
-published in The Bond Buyer and local newspapers, and includes:
>date, time and place of sale
>name and description of issuer
>type of bond
>bidding restrictions
>interest payment dates
>dated date
>maturity structures
>call provisions (if any)
>denominations and registration provisions
>expenses to be borne by purchaser or issuer
>amount of good faith deposit that must accompany the bid
>paying agent or trustee
>name of the firm (bond counsel) providing the legal opinion
>details of delivery
>issuer's right of rejections of all bids
>criteria for awarding the issue
>issuer's obligation to prepare the final official statement and deliver copies to the successful bidder
-*the bond's rating and the underwriter's name are not included in notice of sale because they have yet to be determined
The Bond Buyer
-published every business day and serves as an authoritative source of information on primary market municipal bonds
-the Friday edition publishes the 30-day Visible Supply (the total dollar volume of municipal offering, not including short-term notes, expected to reach the market in the next 30 days)
-publishes the placement/acceptance/ratio indexes (the percentage of new issues sold versus new issues offered for sale the prior week)
-is a subscription wire service of The Bond Buyer that supplies prices, information about proposed new issues, and general news relevant to the municipal bond market
-*provides the most up to-the-minute information relevant to the bond market
Real Time Transaction Reporting System (RTRS)
-up-to-the-minute pricing information regarding eligible municipal bond transactions
-the data is captured and made available to the marketplace within 15 minutes of a trade by the MSRB RTRS
Underwriting Syndicate
-investment bankers interested in placing competitive bids for an issue form syndicates
-an account that helps spread the risk of underwriting an issue among a number of underwriters
-the bidding process is competitive, successive offerings of a particular municipality are often handled by the same syndicate, which is composed of the same members
Syndicate Member Participation
-a syndicate member considers:
>potential demand for the security
>existence of presale orders
>determination and extent of liability
>scale and spread
>ability to sell the issue
Syndicare Letter/Agreement
-competitive bid process
-two weeks before the issue is awarded, the syndicate manager sends the syndicate letter or contract to each participating firm for an authorized signature (signature indicates its agreement with the offering terms)
-Syndicate letters include:
>each member firm's level of participation or commitment
>priority of order allocation
>duration of the syndicate account
>appointment of the manager (s) as agent (s) for the account
>fee for the managing underwriter and breakdown of the spread
>other obligations, such as member expenses, good faith deposits, observance of offering terms, and liability for unsold bonds
Syndicate Contract/ Agreement Among Underwriters
-negotiated underwriting
Western Account
-divided account
-each underwriter is responsible only for its own underwriting allocation
Eastern Account
-undivided account
-each underwriter is allocated a portion of the issue
-after distribution, each underwriter is allocated additional bonds representing its proportionate share of any unsold bonds
Due Diligence
-feasibility study for Revenue bonds which focuses on the projected revenues and costs associated with the project and an analysis of competing facilities
Syndicate Bid
-syndicate arrives at a competitive bid over a series of meetings where member dealers discuss the proposed reoffering scale and spread
-Goal: best price to issuer while still making a profit
-if the member dealers cannot all agree in a final bid, the syndicate can go ahead with its bid as long as the syndicate members agree to abide by the majority's decision
Writing the Scale
-the process of establishing the reoffering yield (or price) for each maturity
-a normal scale has higher yields for long-term bonds
-its first determining what prices (yields) are necessary in order to be able to sell the various serial maturities and then backing off a little to arrive at a bid
Firm Commitment
-competitive bids are submitted this way
-bids must be competitive yet profitable
Disclosure of Fees
-fees to be paid to a clearing agency and the syndicate manager must be disclosed to syndicate members in advance
-part of the syndicate letter or agreement among underwriters
Net Interest Cost (NIC)
-the municipal bond issue is awarded to the syndicate that offers to underwrite the bonds at the lowest net interest cost or true interest cost (TIC)
-common calculation used for comparing bids and awarding the bond issue
-NIC = amount of proceeds the issuer receives + the total coupon interest it pays
True Interest Cost (TIC)
-provides the same type of cost comparison adjusted for the Time Value of money
Split-Rate Bids
-bids with more than one interest rate
-interest is determined by the lowest average interest cost to the issuer
-award goes to syndicate with the lowest rate
Good Faith Deposit
-usually 1-2% of the total par value of the offering
Syndicate Account
-created when the issue is awarded
-all sale proceeds are deposited here
-all expenses are paid out of the account
-settlement of the account is 30 calendar days after the issuer delivers the securities to the syndicate
Syndicate Manager
-responsible for keeping the books and managing the account
-may notify other firms who are not syndicate or selling group members of the new issue through The Bond Buyer
Reoffering Price/Yield
-the price at which the bonds are sold to the public
-the syndicate's compensation for underwriting the new issue
-the difference between the price the syndicate pays the issuer and the reoffering price
-depending on their role, each member of the syndicate is entitled to a portion of the spread
-*one bond point = $10
Syndicate Management Fee
-the syndicate manager receives a per-bond fee for its work in bringing the new issue to market
-*SMALLEST portion
Total Takedown
-the portion of the spread that remains after subtracting the management fee
-*members buy the bonds from the syndicate manager at the takedown
-*LARGEST portion
-*the concession plus the additional takedown
-since the selling group assumes no financial risk, they receive compensation for helping to sell the new issue
-*the discount the selling group receives from the syndicate member
-selling group members buy bonds from syndicate members at the concession
Additional Takedown
-the remainder of the total takedown that the syndicate members keep
-paid to syndicate members when bonds are sold through a selling group
-generally one-half of the concession amount
-interested firms may buy the bonds from the syndicate at a small discount from the reoffer price
Priority Allocation Provisions
-MSRB requires syndicates to establish priority
-normally included in the syndicate agreement
-managing underwriter must submit these provisions to all syndicate members in writing
-syndicate members must signify in writing their acceptance of the allocation priorities
Order Period
-the time set by the manager during which the syndicate solicits customers for the issue and all orders are allocated without regard to the sequence in which they are received
-usually runs for 1 hour on the day after the award of the bid
Allocation Priorities
-especially important when a bond issued is oversubscribed
-order: PGDM- Presale, Group, Designated, Member
-*within 2 business days of the sale date, the syndicate manager must send a written summary of how orders were allocated to the other syndicate members
Presale Order
-entered before the date that the syndicate wins the bid
-means that a customer is willing to place an order without knowing the final price or whether the syndicate will even win the bid
-takes priority over other types of orders
-the takedown is split among all syndicate members according to participation
Group Net Order
-a group order is placed after the bid is awarded
-entered to receive priority for customers
-takedown is deposited in the syndicate account, and upon completion of the underwriting, is split among all syndicate members according to participation
Designated Orders
-the next highest priority
-these orders are usually from institutions that wish to allocate the takedown to certain syndicate members
Member Order
-lowest priority
-a member firm enters such an order for its own inventory or related accounts (like a UIT)
-must disclose member orders
-the securities are authorized, but not yet issued
-new municipal bonds are usually sold this way
GO Bond Backing
-backed by a community's general wealth:
>property values
>retail sales per capita
>local bank deposits and bank clearings
>diversity of industry in its tax base
>population growth or decline
Quantitative Analysis
-focuses on objective information regarding a municipality's population, property values, and per capita income
Qualitative Analysis
-focuses on subjective factors that affect a municipality's securities
>community's attitude toward debt and taxation
>plans and projects
>population trends
>property value trends
Income of the Municipality
-income and sales taxes are major sources of state income
-real property taxes are the principal income source of counties and school districts; real property taxes are the largest source of city income
-city income can include fines, license fees, assessments, sales taxes, hotel taxes, city income taxes, utility taxes, and any city personal property tax
Ad Valorem Tax
-per value, tax
-based on a property's assessed valuation, a percentage of the estimated market value
Official Statement Analysis
-the municipality might need to issue more debt if:
>its annual income is not sufficient to make the payments on its short-term (floating) debt
>principal repayments are scheduled too close together
>sinking funds for outstanding term bonds are inadequate
>pension liabilities are unfunded
>it plans to make more capital improvements soon
Debt Statement
-used in the analysis of GO debt
-includes the estimated full valuation of taxable property, the estimated assessed value of property, and the assessment percentage
Total Debt
-Self-supporting debt
-sinking fund accumulations
=net direct debt
+overlapping debt
=net total debt
Quality of Revenue Bonds
an investor should consider:
-Economic justification
-Competing facilities
-Sources of revenue
-Call provisions
-Flow of funds
Flow of Funds
-the issuer pledges to pay expenses in a specific order
Gross Revenue Pledge
-issuer pays debt service first from gross revenues
-user pays operations and maintenance
Net Revenue Pledge
-issuer pays expenses (operations and maintenance) first from gross revenue
-issuer pays debt service second
Net debt to assessed valuation
-a ratio of 5% ($5,000 of debt per $100,000 of assessed property value) is considered reasonable for a muni
Net debt to estimated valuation
-assessed valuation varies among muni's, so most analysts prefer to use estimated valuation of property
Taxes per person or per capita
-equals the city's tax income divided by the city population; it is used to evaluate the population's tax burden
Debt per capita
-larger cities can assume more debt per capita because their tax bases are more diversified
Debt trends
-this number indicates whether the ratios are rising or falling
Collection Ratio
-equals the taxes collected divided by the taxes assessed; it can help detect deteriorating credit conditions
Coverage Ratio
-(times interest earned ratio) shows how many times annual revenues will cover debt service
Municipal Bond Insurance
-rated AAA
-generally issued with lower coupon rates bc of added safety
-National Public Finance Guarantee Corp. (formerly the Municipal Bond Investors Assurance Corporation-MBIA)
-Financial Guaranty Insurance Company (FGIC)
-Assured Guaranty Corp (AGC)
-AMBAC Indemnity Corp (AMBAC) (no longer insuring)
Bond Ratings
-short-term municipal notes
>Moody's short-term MIG ratings are from MIG 1 (best quality) to MIG 4 (adequate quality)
>speculative notes: listed as SG
>S&P speculative: SP-1, SP-2, SP-3
>Fitch speculative: F-1, F-2, F-3
-any bid for or offer of municipal securities
Quotation Request
-bid wanted or offer wanted
YTM Basis
-how municipal bonds are usually priced and offered for sale, rather than a dollar price
-*also known as a Basis Quote
Dollar Bonds
-are usually term bonds callable before maturity
Bona Fide Quotes
- (or firm quote) must reflect the dealer's best judgement and have a reasonable relationship to the fair market value for that security
-may reflect the firm's inventory and expectations of market direction
-need not have the best price, but it must have a reasonable relationship to fair market value
Workable Indication
-reflects a bid at which a dealer will purchase securities from another dealer
-a dealer is always free to revise its bid for the securities as market conditions change
Nominal Quotation
-indicates a dealer's estimate of a security's market value
-provided for informational purposes only and are permitted if the quotes are clearly labeled as such
-rules on nominal quotes apply to all municipal bond quotes distributed or published by any dealer
Out-Firm with Recall
-quote that is firm for a certain time
-are firm for an hour (or half hour) with a five-minute recall period
-allows a dealer to try to sell bonds that it does not own, knowing that if it finds a buyer within the allotted time, it can buy the bonds at a fixed price from the firm providing the out-firm quote
Secondary Market Joint/Trading Accounts
-often formed by a group of investment bankers to purchase large blocks of bonds from institutions and resell them
-as with underwritings, the size of the financial commitment requires more than one firm to handle such an undertaking
National Securities Clearing Corporation (NSCC)
-municipal securities dealers must report trades with other dealers to NSCC
-the report must include the two executing firms' names and the amount of accrued interest, if known
Broker's Broker
-protect the identity of their customers
-they act solely as agents and do not maintain an inventory of bonds
-their business focuses on helping other municipal dealers place unsold portions of new bond issues
Antireciprocal Rule
-a dealer cannot solicit trades in municipal securities from an investment company in return for sales by the dealer of shares or units in the investment company
Customer Recommendations
-MSRB rules require municipal securities brokers and dealers to make suitable recommendations to customers
-before making a recommendation, a municipal securities firm must make a reasonable effort to learn the customer's financial status, tax status, investment objectives, and other holdings
-*before an account is opened, it must be approved in writing by a principal
-*dealer may not guarantee against loss
Suitability Test
-applies to discretionary accounts as well as to other accounts
-the practice of increasing commissions through excessive trading; is prohibited
Control Relationship
-exists if the dealer controls, is controlled by, or is under common control with that security's issuer
-subject to additional disclosure requirements
-initially can be verbal, the dealer must make a written disclosure at or before the transaction's completion.
-the disclosure is usually made on the confirmation
-for a discretionary account, the customer must give express permission before the transaction can be executed
- a dealer acts as an agent when it arranges trades for customers and charges commissions
-a dealer acts as a principal when it buys for or sells securities from its own inventory
-the dealer charges a Markup for a principal transaction when it sells securities to customers
-the dealer charges a Markdown when it buys securities from customers
-not disclosed separately on a customer's confirmation
Principal transactions
-executed a a net price, includes the markup or markdown
-factors include:
>dealer's best judgement of fair market value
>expense of effecting the transaction
>fact that the dealer is entitled to a markup or markdown (profit)
>total dollar amount of the transaction
>value of any security exchanged or traded
Agency Transaction
-for an agency commission calculation, a dealer takes into consideration the:
>security's availability
>expense of executing the order
>value of services the dealer renders
>amount of any other compensation received or to be received in connection with the transaction
-customers must receive a written confirmation of each municipal securities transaction they have entered
-must disclose the security;
>list the trade date
>settlement date
>amount of accrued interest
>state the firm's name, address, phone number
>indicate whether the firm acted as agent or principal in the trade
>agency transaction: the name of the party on the other side of the transaction and the source and amount of any commission
>whether the securities are fully registered, registered as to principal only, in book-entry form, or in bearer form
>whether securities are called or pre-refunded, as well as the date if maturity fixed by the call notice and the amount of the call price
>any special qualification or factor that might affect payment of principal or interest
>whether the bond interest is taxable or subject to the alternative minimum tax (AMT)
Disclosing Yield
-if the bond is noncallable, the actual life of the bond is known with certainty
-if the bond is callable, the problem is the uncertainty surrounding a possible call
>Discount bonds are not likely to be called
>Premium bonds are likely to be called
-the MSRB requires that the yield shown on a customer confirmation be the lower of YTM or YTC
>Discount: lower is YTM
>Premium: lower is YTC
Variable Rate Bonds
-no separate yield disclosure is required
-as the coupon is adjusted periodically, a yield computation is impossible
Bonds in Default
-no separate yield disclosure is required
-if a bond is no longer paying interest, a yield computation is impossible
Bonds Sold at Par
-no separate yield disclosure is required
-for bonds sold at par, no separate yield disclosure is required because the yield cannot be anything other than the coupon rate.
-*at par, all yields are the same
-any material designed for use in the public media:
>abstracts and summaries of the official statement
>offering circulars
>market letters
>form letters (professional, product or new issue)
-a municipal or general securities principal must approve
-*preliminary and final official statements are not considered advertising becase they are prepared by or on behalf of an issuer
Financial Adviser
-a financial advisory relationship exists when a municipal dealer provides financial advisory or consulting services to an issuer with respect to a new issue for a fee or other compensation
-relationship must be documented in writing before, upon, or promptly after its inception
-document establishes basis of compensation
Conflicts of Interest
-arise if a firm acts as both underwriter and financial adviser for the same issue
-competitive bid: a dealer that has a financial advisory relationship with the issuer can purchase all or part of the new issue if the issuer has consented in writing before the bid to such participation
-negotiated sale:a municipal dealer that has a financial advisory relationship can buy all or part of a new issue if:
>it expressly discloses in writing to the issuer at or before the termination of the relationship that a conflict of interest may exist, and the issuer expressly acknowledges it in writing to the broker/dealer receiving such disclosure
>the b/d discloses in writing at or before termination the source of the anticipated amount of all remuneration to the b/d with respect to the issue
Tax Reform Act of 1986
-restricted the federal income tax exemption of interest for municipal bonds to public purpose bonds, which are bonds issued to finance projects that benfit citizens in general rather than particular private interests
-if a bond channels more than 10% of its proceeds to private parties, it is considered a private activity bond and is not automatically granted tax exemption
Tax-Equivalent Yield
-tax free yield/ (100% -the investor's tax rate)
No Interest Deductions
-the expenses associated with purchasing or holding municipal bonds are non deductible
-includes interest on loans to acquire bonds, such as margin loans, and safe deposit box rental
Exception for Banks
-when banks purchase certain issues of GO bonds, they are allowed to deduct 80% of the interest carrying cost of the deposits funding the purchase of bonds
-established by The Securities Acts Amendments of 1975 as an independent SRO
-governs the issue and trade of municipal securities
-rules require municipal securities underwriters and dealers to proctect investors' interests, be ethical in offering advice, and be responsive to complaints and disputes
-does NOT regulate issuers
-has NO authority to enforce the rules it makes; rules are enforced by FINRA
-the FRB enforces MSRB rules governing any nonnational banks that are member of the Federal Reserve System
-the FDIC enforces MSRB rules for non-national banks that are NOT members of the FRS
Rule G-12
- outlines the procedures, or uniform practices, for settling transactions between municipal securities firms:
>Cash Trades: settle on the trade date
>Regular Way Trades: settle on the third business day after the trade date
-Securities that are not in good delivery form are rejected or reclaimed, but it does not invalidate the trade; the seller is still obligated to sell the securities
-Good delivery requirements:
>denominations of $1,000 or $5,000 for bearer bonds
>Registered bonds are delivered in multiples of $1,000 par value, with a maximum par value on any one certificate of $100,000
-Mutilated certificates are not good delivery unless the transfer agent or some other acceptable official of the issuer validates the security. Must endorse to be good delivery
-Partial call: the called securities are not good delivery unless they are identified as called when traded
Rule G-15
-Confirmations of trades must be sent or given to customers at or before a transaction's completion
-Must include:
>b/d's name, address, and telephone number
>customer's name
>detailed description of the security, including issuer, interest rate and maturity, whether it is callable
>trade date and time of execution
>settlement date
>CUSIP number. if any
>yield and dollar price
>amount of accrued interest
>extended principal amount (the total principal of all securities the information covers)
>total dollar amount (the extended principal plus any accrued interest)
>whether the firm acted as broker or dealer (if it acted as broker, the name of the person on the other side of the trade must be given, if requested, and the dollar amount of commission earned from both parties must be disclosed)
>dated date, if it affects the interest calculation and the first interest payment date
>level of registration of the security (fully registered, registered as to principal only, or book-entry)
>whether the bonds are called or pre-refunded
>any other special fact about the security traded (escrowed to maturity, ex-legal trade, federally taxable, or odd denominations)
-the MSRB prohibits b/d's from recommending municipal securities to a customer if a b/d has not obtained the customer's financial information, tax status, and investment objectives, even if the b/d has reasonable grounds to believe that the recommendation is suitable for the customer
-Principal must approve in writing:
>the opening of new customer accounts
>every municipal securities transaction
>actions taken on customer complaints
>correspondence regarding municipal securities trade
-every b/d, must have a financial and operations principal (FinOp) who maintains the financial books and records
-when a new issue of municipal securities is delivered to a customer, a copy of the official statement must accompany or preced the delivery
-if the issue is a negotiated underwriting, the municipal form must disclose in writing to the customer the amount of the spread, the amount of any fee received if the firm acted as an agent in the sale, and the initial offering price for each maturity in the issue
-there is no requirement to disclose the spread in competitive underwritings
-prohibits municipal firms from engaging in municipal securities business with an issuer for two years after any political contribution is made to an official of that issuer (negotiated underwriting)
-up to $250 per election
Telemarketers calling on behalf of a firm may not call a person before 8:00 am or after 9:00 pm in the called person's time zone
Tracking Municipal Securities
-tax-exempt bonds are listed in financial publications such as The Bond Buyer and The Wall Street Journal
Electronic Municipal Market Access (EMMA)
-centralized online site to locate key information about municipal securities
-presented for retail, non-professional investors
-makes available official statements for most new muni bond offerings, 529 college savings plans, and other muni securities
-*provides real-time access to prices as well as prices and rates from remarketing agents regarding auction rate securities