Series 7 Municipal Bond Exam Overview

Municipal bond topics typically comprise approximately 15 to 25 questions on the Series 7 exam, also known as the General Securities Representative Exam (GSRE), which is the test all stockbrokers must pass, to trade securities.

Municipal bonds fall under the following two broad categories:

1. 澳洲幸运5官方开奖结果体彩网:General obligation (GO) bonds, which are backed by the credit and taxing power of the jurisdiction that issues them
2. Revenue bonds, which finance income-producing projects and are secured by a specified revenue source

Testers who can clearly differentiate between these bonds stand a greater chance ofꦦ correctly answering muni bonds 🐻questions. This article sheds light on both bond types.

Revenue vs. General Obligation Bonds

When 🐎working on practice questions, a comparison chart can greatly help distinguish GO bonds from revenue bonds.

Municipal Notes

Municipal 澳洲幸运5官方开奖结果体彩网:debt instruments that are not classified as bonds, due to their short maturities are called "澳洲幸运5官方开奖结果体彩网:municipal notes.” These short-term cash-flow instruments come in the following variations:

• 澳洲幸运5官方开奖结果体彩网:Tax Anticipation Notes (TAN): Issued to smooth out a city's cash flow between tax collection periods.
• 澳洲幸运5官方开奖结果体彩网:Revenue Anticipation Notes (RAN): Similar to TANs.
• 澳洲幸运5官方开奖结果体彩网:Bond Anticipation Notes (BAN): Issued to raise funds when a bond has been issued, but money has not yet been received. The proceeds of the bond issue will pay off the BAN.
• Tax and Revenue 澳洲幸运5官方开奖结果体彩网:Anticipation Notes (TRAN)

Moody's Investment Grade (MIG) rating system rates bond notes. And althoughꦫ actual ratings have never surfaced on the Series 7 exam, MIG itself has reportedly been referenced on certain questions. 

Trust Indentures and Revenue Bonds

Trust 澳洲幸运5官方开奖结果体彩网:indentures, which are legally binding contracts between bond issuers and trustees that represent bondholder interests, are present with revenue bonds, but not with GO bonds. Trust indentures are essentially a set of terms that both parties must adhere to, that may also indicate where the bond’s income source derives from.

Because municipal bonds are exempt from f🧸ederal regulations, trust indentures go a long way in protecting bondholders, and are hence sometimes referred to as “protective covenants.”

$\begin{aligned} &\text{PTD}=\text{AV}\times\text{Millage Rate}\\ &\textbf{where:}\\ &\text{PTD = Property taxes due}\\ &\text{AV}=\text{Estimated Market}\left(\text{Sale}\right)\times\text{Assessment Rate}\left(\%\right)\\ &\text{AV = Assessed value}\\ &\text{Millage Rate}=\$0.001\text{ or }1/10\text{th of a cent}\\ \end{aligned}$​PTD=AV×Millage Ratewhere:PTD = Property taxes dueAV=Estimated Market(Sale)×Assessment Rate(%)AV = Assessed valueMillage Rate=$0.001 or 1/10th of a cent​

Revenue Bond Covenants

GO and revenue bonds demand unique analytical approaches, due to their different funding sources. Recall that GO bonds are backed by the taxing power of the issuer. Pointedly: the money essentially comes from property taxes called “ad valorem” taxes, where the amount is based on the value of a transaction or of property.

Series 7 candidates most likely will not ever be required to compute 澳洲幸运5官方开奖结果体彩网:property taxes, however, they may be required🎐 to know the following basic property tax com𓂃putation formula:

$\begin{aligned} &\text{EV * AR(\%) = AV * MR (1 Mill) = TD}\\ &\textbf{where:}\\ &\text{EV = Estimated market (sale) value}\\ &\text{AR(\%) = Assessment rate}\\ &\text{MR = Millage rate}\\ &\text{1 Mill = \$0.001 or 1/10th of a cent}\\ &\text{TD = Taxes due}\\ \end{aligned}$​EV * AR(%) = AV * MR (1 Mill)𓆉 = TDwhere:EV = Estimated m🌺arket (sale) valueAR(%) = Assessment rateMR = Millage rate1 Mill = $0.001 or&nb🦩sp;1/10th of a&ওnbsp;centTD = Taxes due​

The Major Factors of Muni Bonds

𝓰 Gen🌳eral Obligation Revenue Major Factors and Tools

• Community attitude toward public debt and taxes (recall voter approval is required)
• Population base—growing or declining?
• Unemployment rate
• Economic diversity—is it a one-industry city?
• Tax base
• The assessed value of the property (recall ad valorem taxes)
• Municipal debt statement—a major tool for analyzing GO bonds—the basic outline
• Estimated sale (market) value of taxable property
• The assessed value of taxable property
• Direct debt (i.e., debt that is specifically the liability of the city)
• Debt limits (ceiling)
• Demographics and economic health

Plus:

• Overlapping (澳洲幸运5官方开奖结果体彩网:coterminous) debt—shared by more than one jurisdiction (e.g., city and county)

Minus:

• Self-supporting debt (double-barreled bonds)

Equals:

• Net overall debt

Economic justification:

• Is it reasonable to expect that a proposed facility can pay for itself?

澳洲幸运5官方开奖结果体彩网:Feasibility study:

• This study, which explores costs and potential revenues from a proposed facility, typically contains a competitive facilities section, which assesses the impact of competing businesses that sell similar goods or services, on a project’s potential long-term revenues.

澳洲幸运5官方开奖结果体彩网:Debt coverage ratio:

• How many times do the current/expected revenues cover the bond's debt service requirements?

Bringing New Bonds to Market

The processes of bringing new bonds to market widely differ, between GO bonds and revenue bonds. For revenue bonds, the principal 澳洲幸运5官方开奖结果体彩网:underwriter is chosen by the issuer of the bonds, while GO bond underwriting contracts are awarded by a competitive sealed bid sale.

Prior to issuing any municipal bond, issuers commission attorneys known as “澳洲幸运5官方开奖结果体彩网:bond counsels” to render legal opinions. Tax lawyers are frequently tapped for thꦑe gig because tax implications are such a looꦰming concern to most bond investors.

The legal opinion will include the following:

• The authority to borrow, demonstrating the legality for this entity to borrow money via municipal bonds under state and federal laws.
• 1933 Act exemption, which states that municipal issuers are exempt from filing registration statements with the SEC.
• Tax exemption, which states that the interest from municipal bonds is normally exempt from federal taxation. The legal opinion cites the appropriate laws that support this position.

A copy of the legal opinion, which must accompany delivery of all municipal bonds, come in one of🐽 the following two types:

• Unqualified opinion: The bond counsel has no reservations about the issuer's authority to borrow, the nature of the bond, and the tax exemption. This is usually called an “approving” opinion of counsel.
• Qualified opinion: The bond counsel expresses concerns about some or many aspects of the bond.

Another chief distinguishing factor between the two bond types is that GO bღonds are subject to voter approval, which is not the case with revenue bonds.

The following chart refers to GO bonds, which are of greater import to the Series 7
exam.

Underwriting GO Bonds

Orders for the Purchase of Munis

Orders for the purchase of municipal bonds are filled in a priority sequence specified in the syndicate's priority allocation provisions, which are specified in the 澳洲幸运5官方开奖结果体彩网:underwriting agreement and are provided to all syndicate members. These often popular municipal issues may be 澳洲幸运5官方开奖结果体彩网:oversubscribed, meaning ther🦂e are more orders for bonds than there are bonds themselves.

The order period in which the syndicate solicits and accepts orders for bondꦺs is established by the syndicate manager, and orders are filled according to the following sequence, regardless of the 💧time sequence in which they were received.

1. Pre-sale: These orders are entered before the syndicate wins the bid. Customers are willing to commit to buying bonds without specific information on the exact price/yield.
2. Group net: The proceeds of sales from these orders are placed in the syndicate bank account and distributed to members of the syndicate according to their participation upon completion of the underwriting.
3. Designated: These orders specify which member of the syndicate is to receive credit for the order. Note that they are filled after the group orders.
4. Member: The last to be filled in the priority sequence, these orders are placed by members of the syndicate looking to buy bonds for their own proprietary inventory.

The Series 7 exam frequently asks about this priority sequence, and so it’s worth learning the mnemonic: Pro Golfers Don't Miss (PGDM), which helps testers remember: pre-sale, group net, designated, and member orders.

The syndicate buys the bonds from the issuer and sells (re-offers) the bonds to the public at a markup, known as the "澳洲幸运5官方开奖结果体彩网:underwriting spread." The typical allocation of the spread is shown in the following example of ⛦a 1-point ($10) spread:

The total takedown earned by syndicate members for their own sales is the selling 澳洲幸运5官方开奖结果体彩网:concession plus the additional takedown. 📖In this example, the total takedown is $9 per bonꦛd.

When the bonds are delivered to buyers and a settlement is made, the buyer receives a final confirmation and a copy of the official statement, if it has been completed. If the final official statement is not ready, the buyer will receive a copy of the preliminary official statement, which is subjec💜t to amendment.

If the bonds themselves are not ready for delivery, the customer will receive a temporary confirmation known as a "when issued" confirm. This document does not show the following:

• 澳洲幸运5官方开奖结果体彩网:Settlement date, because that has yet to be determined
• 澳洲幸运5官方开奖结果体彩网:Accrued interest, because the exact settlement has not been determined
• The total dollar amount, because the accrued interest must be added to the 澳洲幸运5官方开奖结果体彩网:purchase price to produce the total dollar amount

The Bottom Line

Municipal bonds and securities are featured in three out of four sections in the 125 question Series 7 exam. Mastering these questions is key to achieving a passing score a�🥃�nd achieving Series 7 glory.