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Term Paper

Municipal Securities Market

Rayn Angel Quejano


BSBA3-FM
March 7, 2017
1. What are the Types of Municipal Securities and why they are issued?

Answer: There are basically two different types of municipal bond security structures:
>Tax-backed bonds
> Revenue bonds
There are also securities that share characteristics of both tax-backed and revenue bonds.
Tax-Backed Debt
*Tax-backed debt obligations are instruments issued by states, counties, special districts,
cities, towns, and school districts that are secured by some form of tax revenue. Tax-
backed debt includes general obligation debt, appropriation-backed obligations, and debt
obligations supported by public credit enhancement programs. The broadest type of tax-
backed debt is general obligation debt. An unlimited tax general obligation debt is the
stronger form of general obligation pledge as it is secured by the issuers unlimited taxing
power. A limited tax general obligation debt is a limited tax pledge because for such debt
there is a statutory limit on tax rates that the issuer may levy to service the debt. Agencies
or authorities of several states have issued bonds that carry a potential state liability for
making up shortfalls in the issuing entitys obligation. However, the states pledge is not
binding. Debt obligations with this nonbinding pledge of tax revenue are called moral
obligation bonds.
> Revenue Bonds
*The second basic type of security structure is found in a revenue bond. Such bonds are
issued for either project or enterprise financings in which the bond issuers pledge to the
bondholders the revenues generated by the operating projects financed. For a revenue
bond, the revenue of the enterprise is pledged to service the debt of the issue. The details
of how revenue received by the enterprise will be disbursed are set forth in the trust
indenture. There are various restrictive covenants included in the trust indenture for a
revenue bond to protect the bondholders. A rate, or user charge, covenant dictates how
charges will be set on the product or service sold by the enterprise.
Hybrid and Special Bond Securities
Some municipal bonds that have the basic characteristics of general obligation bonds and
revenue bonds have more issue-specific structures as well.
Insured bonds, in addition to being secured by the issuers revenue, are also backed by
insurance policies written by commercial insurance companies.
Because municipal bond insurance reduces credit risk for the investor, the marketability
of certain municipal bonds can be greatly expanded.
There are two major groups of municipal bond insurers.
*The first includes the monocline companies that are primarily in the business of
insuring municipal bonds.
*The second group of municipal bond insurers includes the multiline property and
casualty companies that usually have a wide base of business, including insurance for
fires, collisions, hurricanes, and health problems.
> Redemption Features
Municipal bonds are issued with one of two debt retirement structures, or a combination.
Either a bond has a serial maturity structure or it has a term maturity structure.
A serial maturity structure requires a portion of the debt obligation to be retired each year.
A term maturity structure provides for the debt obligation to be repaid on a final date.
Municipal bonds may be called prior to the stated maturity date, either according to a
mandatory sinking fund or at the option of the issuer. The municipal market has securities
with various features. These are zero-coupon bonds, floating-rate bonds, and potable
bonds in the municipal bond market. For this market, there are two types of zero-coupon
bonds. One type is issued at a very deep discount and matures at par.
The difference between the par value and the purchase price represents a predetermined
compound yield. These zero-coupon bonds are similar to those issued in the taxable bond
market for Treasuries and corporates. The second type is called a municipal multiplier.
This is a bond issued at par that has interest payments. The interest payments are not
distributed to the holder of the bond until maturity, but the issuer agrees to reinvest the
undistributed interest payments at the bonds yield to maturity when it was issued.

2. What are the Risks unique to investing in Municipal Securities

Answer: The investor in municipal securities is exposed to the same risks affecting
corporate bonds plus an additional one that may be labelled tax risk.
There are two types of tax risk to which tax-exempt municipal securities buyers are
exposed.
1.The first is the risk that the federal income tax rate will be reduced.
2.The second type of tax risk is that a municipal bond issued as a tax-exempt issue may
eventually be declared to be taxable by the Internal Revenue Service.

3. What are the yield relationship between municipal securities and taxable bonds?

Answer: A common yield measure used to compare the yield on a tax-exempt municipal
bond with a comparable taxable bond is the equivalent taxable yield, which is computed
as:
0.065
equivalent taxable yield 0.1083 or 10.83%
1 0.04
Example: Suppose that an investor in the 40% marginal tax bracket is considering the
acquisition of a tax-exempt municipal bond that offers a yield of 6.5%. What is the
equivalent taxable yield? 6.5%/(1-40%)
yield on municipal bond
yield ratio
yield on same maturity Treasury bond
Because of the tax-exempt feature of municipal bonds, the yield on municipal bonds is
less than that on Treasuries with the same maturity. The yield on municipal bonds is
compared to the yield on Treasury bonds with the same maturity by computing the
following ratio: tax-exempt
equivalent taxable yield
1 marginal tax rate
Yield spreads within the municipal bond market are attributable to differences between
credit ratings (quality spreads), sectors within markets (intramarket spreads), and
differences between maturities (maturity spreads).
Primary Market
Municipal obligations are brought to market weekly.
A state or local government can market its new issue by offering bonds publicly to the
investing community or by placing them privately with a small group of investors.
When a public offering is selected, the issue usually is underwritten by investment
bankers and/or municipal bond departments of commercial banks.
Most states mandate that general obligation issues be marketed through competitive
bidding, but generally this is not required for revenue bonds.
An official statement describing the issue and the issuer is prepared for new offerings.
Municipal bonds have legal opinions that are summarized in the official statement.
Secondary Market
Municipal bonds are traded in the over-the-counter market supported by municipal bond
dealers across the country.
Markets are maintained on smaller issuers (referred to as local general credits) by
regional brokerage firms, local banks, and by some of the larger Wall Street firms.
Larger issuers (referred to as general names) are supported by the larger brokerage firms
and banks, many of whom have investment banking relationships with these issuers.
The convention for both corporate and Treasury bonds is to quote prices as a percentage
of par value with 100 equal to par.
Municipal bonds, however, generally are traded and quoted in terms of yield (yield to
maturity or yield to call).
The price of the bond in this case is called a basis price.
The exception is certain long-maturity revenue bonds.
A bond traded and quoted in dollar prices (actually, as a percentage of par value) is called
a dollar bond.
The Taxable Municipal Bond Market
Taxable municipal bonds have their interest taxed at the federal level.
Because there is no tax advantage, an issuer must offer a higher yield than for another
tax-exempt municipal bond. There are three reasons why a municipality would want to
issue a taxable municipal bond and thereby have to pay a higher yield than if it issued a
tax-exempt municipal bond: Some activities do not benefit the public at large and
municipalities have to finance these restricted activities in the taxable bond market.
The U.S. income tax code imposes restrictions on arbitrage opportunities that a
municipality can realize from its financing activities. Municipalities do not view their
potential investor base as solely U.S. Investors. When bonds are issued outside of the
United States, the investor does not benefit from the tax-exempt feature.
The most common types of activities for taxable municipal bonds used for financing are:
local sports facilities investor-led housing projects advanced refunding of issues that are
not permitted to be refunded because the tax law prohibits such activity underfunded
pension plan obligations of the municipality.

4.What is the degree of regulation of the municipal securities market?

Answer: The degree of regulation of municipal securities are Municipal Securities Rule
making Board,
Board,Financial Industry Regulatory Authority FINRA is an SRO that oversees more
than 4,400 securities firms and nearly 630,000 registered securities representatives in the
United States FINRAs responsibilities include:
regulating broker-dealers and their registered persons;
providing market information;
adopting and enforcing rules to protect investors and the financial markets;
examining broker-dealers for compliance with FINRA rules as well as federal securities
laws, including the rules and regulations there under, and MSRB rules;
informing and educating the investing public;
providing industry utilities; and
administering the largest dispute resolution forum for investors and registered firms. 199
While its responsibilities extend well beyond the municipal securities market, FINRA plays
an instrumental role in overseeing the registration and examination process for municipal
dealer

Reflection:
In FM 115 or Capital Markets Management, in whole second sem of studying FM115they
have a lot of knowledge that we learned in this subject like in terms in markets, when we
talked about market they are combination of buyer and seller meet together rand many
types of market and also financial asset, depository Institutions and types of depository
institutions. There are four, first is commercial bank, savings and loans association,
saving bank and lastly is credit union. Also I Learned a topic of economic assumptions,
swaps, caps and floor markets and the types of swaps that I very forgot in this time. First
is interest rate swap, interest rate equity swap, currency swap and lastly is credit default
swap, also I interested to a topic of swap because they have a computation that I will
understand and also a valuation of debt contracts and their price volatility . FM115 is not
easy to understand if your professor is not better to teach, but the helped of our professor
which is sir Mark Anthony Delgado they will be easy to understand.

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