A municipal authority issues industrial development revenue bonds to build a plant leased to a manufacturing company. When evaluating the credit quality of these bonds, an analyst should focus primarily on:

The financial strength of the corporation making the lease payments

The authority's property tax base

The state's willingness to appropriate funds

The population growth of the municipality

Public housing authority (PHA/NHA) bonds are considered among the safest municipal securities because they are:

Backed by the full faith and credit of the U.S. government

Backed by the taxing power of the issuing state

Secured by first mortgages on the housing units insured by private insurers

Protected by a moral obligation of the state legislature

An investor buys a variable-rate demand obligation (VRDO). Which feature gives the investor liquidity?

The right to put (tender) the bond at par on a reset date, typically supported by a bank liquidity facility

The rate is reset through a Dutch auction with no liquidity backstop, so holders can exit only if enough new bidders appear at each auction

The bond pays a fixed rate and can be sold only at maturity

The issuer must redeem the bond whenever market rates rise

Under a net revenue pledge, facility revenues are applied in which order?

Operations and maintenance first, then debt service

Debt service first, then operations and maintenance

Debt service reserve first, then bondholders, then operations

Surplus fund first, then operations and maintenance

A customer in the lowest federal income tax bracket with a small taxable account asks for income investments. Recommending long-term municipal bonds would most likely be:

Unsuitable, because the tax exemption provides little benefit and taxable bonds would likely yield more after tax

Suitable, because municipal bonds are always the safest income investment and their tax exemption benefits investors in every tax bracket equally

Suitable, because municipal interest is exempt from capital gains tax

Unsuitable, because municipal bonds cannot be held in individual accounts

Series 7 Municipal Securities: Concepts, Examples + Practice

Where it sits in the outline

Parent outline section: F3: Provides Investment Information, Makes Suitable Recommendations (73% of the exam). Municipal securities show up in Function 1 (primary market and communications) and heavily in Function 3: GO vs. revenue analysis, call and refunding features, pricing and tax treatment.

Key concepts

GO vs. revenue. General obligation bonds are backed by the issuer’s taxing power and analyzed on debt per capita, tax base and collection rates. Revenue bonds are backed by a facility’s income and analyzed with feasibility studies, rate covenants and debt service coverage.

Tax treatment. Interest is generally exempt from federal income tax and often from the issuer-state’s tax for in-state residents. Discount accretion on munis bought in the secondary market can be taxable; premium must be amortized with no deduction.

Primary market. Competitive (bid) vs. negotiated sales; the official statement; syndicate roles and the order of allocation.

Pricing. Munis are often quoted on a yield basis; accrued interest uses a 30/360 day count.

Worked example

Muni vs. corporate after tax

A client in the 24% bracket can buy a 3.0% muni or a 3.8% corporate. Taxable-equivalent yield of the muni = 3.0 / 0.76 = 3.95%, which beats 3.8%. At the 12% bracket it is 3.0 / 0.88 = 3.41%, and the corporate wins. The higher the bracket, the more a muni is worth.

Common traps

Munis in tax-deferred accounts lose their advantage.
A revenue bond’s security is the project’s revenue, not the issuer’s taxing power, even when the issuer is a city.

Practice questions on this topic

Series 7 practice questions: Municipal Securities

A city wants to finance a toll bridge and repay the bonds solely from bridge tolls. Which statement about this financing is TRUE?

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Series 7 Municipal Securities

Where it sits in the outline

Key concepts

Common traps

Practice questions on this topic

Series 7 practice questions: Municipal Securities

Drill this section in the full Series 7 bank

Frequently asked questions

Sources

Series 7 Municipal Securities

Where it sits in the outline

Key concepts

Common traps

Practice questions on this topic

Series 7 practice questions: Municipal Securities

Drill this section in the full Series 7 bank

Frequently asked questions

Sources

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