Outline of Examination
I.
Overview of Municipal Bond Market (22)
14%
II.
Capital Financing Methods (21)
13%
III.
Types of Debt (10)
IV.
Structuring and Sizing (22)
V.
Credit Assistance (6)
4%
VI.
Credit Analysis (5)
5%
VII.
The Bond Sale (35)
22%
VIII.
Other Options For Selling Bonds (5)
3%
IX.
The Underwriting Process (9)
6%
X.
Managing Outstanding Debt (14)
XI.
Leasing (8)
(160)
6%
14%
14%
8%
100%
I. Overview of municipal bond market (22)
A. Nature of Borrowers and Purposes of Municipal Debt Issues (8)

B. Investors in Municipal Securities (6)

Types of investors:
Institutional - commercial banks, insurance companies
Retail - individuals
Other Institutional - managed bond funds & unit investment trusts

Individuals are most important group (over 75% of market), purchase bonds directly or in bond
funds.

Tax Reform Act of 1986 made municipal bonds less attractive to banks.
C. Determinants of Municipal Bond Interest Rates (8)

3 significant risks faced by investors
1) Market risk (interest rate risk) - if interest rates rise, then the market value of the bonds
decreases.
2) Credit risk - if credit rating of issuer falls, then the market value of bonds will decrease.
3) Call risk - if bonds are called, then investor has to reinvest proceeds at a lower interest
rate.

Things issuer can do to reduce these risks
1) obtain bond insurance to mitigate credit risk
2) eliminate call provisions to mitigate call risk
3) incorporate security provisions such as:
debt reserve fund
coverage test - available revenues as % of d/s
additional bonds test
II. Capital Financing Methods (21)
A. Possibilities and Advantages/Disadvantages of Each (11)

3 general principles in selecting a funding source for capital improvements
1) Equity - beneficiaries of a project or service should pay for it.
2) Effectiveness - method which provides sufficient amount of capital when it is needed.
3) Efficiency - relative costs of using one financing method over another.

Grants - free, but not common, sometimes restrictive.
Capital Contributions - from developers - usually only partial funding
- from development impact fees
Low interest, subsidized loans - federal or state revolving funds
Joint ventures or privatization
Pay as you go
Debt issuance
B. Policy and Legal Considerations in Selecting and Implementing a Financing Method (10)

Purpose of a debt policy:
1) Provide guidance for acceptable levels of debt and risk
2) Specify objectives
3) Facilitate debt issuance by pre-determination of decisions
4) Promote objectivity and limit political influence

Debt policy should contain:
1) Acceptable levels of S.T. and L.T. debt
2) Purposes for which debt will be issues
3) use of GO debt vs. revenue bonds
4) Mix of pay-as-you-go and debt financing
5) Use of variable rate debt
6) Debt maturity schedules
III. Types of Municipal Debt (10)
A. Categories of Securities
Usually bonds are $5,000 increments, and notes are $100,000 with a one year term.

GO Bonds
- full faith and credit, readily accepted in market, lower interest costs, do not require d/s
reserve fund or trustee, lower issuance costs
- subject to State limits on amount o/s, voter approval, difficult to sell quickly

Revenue Bonds
- less secure than GO, no voter approval reqd., limited by reasonable rates to support
d/s, may also be backed by general taxing authority (“double barreled”)
- more stringent issuance requirements, separate d/s reserve fund, credit enhancement,
bond insurance, bond resolution or trust indenture containing rate covenants, o&m
requirements, etc.

Special Assessment Bonds
- limited segment of community enjoys benefit and pays d/s, no voter approval required
- increased risk, higher interest costs.

Private Activity Bonds
Not tax-exempt if meeting two IRS tests
1) 10% of proceeds to finance private facilities
2) 10% secured by payments from private sources

Tax Increment Financing

Certificates of Participation (COPs)
- govt. leases city hall, d/s payments made to investors who provided funding, tax exempt
interest. No voter approval required. Not subject to debt limits.
- lease payments are subject to annual appropriation
- lower credit rating, higher interest costs

Leasing
- usually used on expensive assets with short lives
- higher interest rates

Test: Which of the following is most likely to be a provision for the issuance of certificates of
participation?
1. Yield restriction requirement for invested proceeds.
2. Non-appropriation clause.
3. Full faith and credit pledge.
4. Voter approval requirement.

Test: All of the following are associated with a revenue bond transaction, EXCEPT a: full faith
and credit pledge.
B. Long-Term Debt
C. Short-Term Debt


Usually less than 1 year
Used to finance cashflow shortfalls while waiting for revenue collections.

Test:
D. Derivatives
TANs, RANs, TRANs, BANs and GANs are all types of: municipal note obligations.
IV. Structuring and Sizing an Issue (22)
A. Security

Security is important for revenue bonds

Can increase security by using:
Capitalized interest
Deferring principal payments
Using capital appreciation bonds
Using credit enhancement

Revenue bonds must consider:
1) Flow of funds - order in which revenues are expended.
2) Bond covenants:
- maintain rate structure
- D/S coverage ratios
- Additional bonds test
- Restricting permissible investments for proceeds
3) Debt service fund
B. Maturity Schedules

Final maturity date determined by project type, finances of issuer, legal constraints

Serial Bonds - specific principal amount retired each year.

Term bonds - large part or all of bond issue comes due in a single maturity.

Capital appreciation bonds (CABs) - bonds which do not pay interest periodically. All interest is
paid at final maturity in one lump sum.

Test: A serial bond structure is one in which: a portion of the issue’s aggregate par value
matures each year.
C. Interest Rates

Fixed rate bonds

Variable rate bonds

Test: Two elements of risk that issuers should consider when issuing variable rate demand
obligations are: interest rate risk and remarketing risk.
D. Debt Service Structure and Schedule Types

2 common d/s structures:
1) level principal maturity schedule
- retires principal evenly over bond life
- total d/s decreases over time as interest decreases.
2) level total debt maturity schedule
- early payments cover mostly interest

Also, variable rate debt - maturity can be 30 yrs, good when interest rates are expected to
decrease significantly.
E. Use of Original Issue Discounts and Premiums

Original Issue Discount (OID) - issuer receives less proceeds than eventual principal repayment.
Results in lower interest rates than current market rate.

Premium - issuer receives more proceeds than par amount.
F. Redemption Features (Call Provisions)

Usually includes a redemption premium that must be paid if bonds are called.

Can be either mandatory or optional redemption. Term bonds are often subject to mandatory
redemption.
G. Sizing Considerations (6)
H. Security and Tax Law - Restrictions and Requirements (8)

Exceptions to arbitrage:
1) Less than $10 million issued in year
2) Spend all within 6 months
3) Spend all for capital project within 18 months
4) Spend all for regular bonds within 24 months

Over Issuance
1) Must be reasonable in relation to project costs - lesser of 5% or $100,000
2) Spend 85% within 3 years
3) Must obligate 5% within 6 months
4) Diligent in completion of project
V. Credit Assistance (6)
A. Types

Bond insurance - full term of bonds.
Letters of credit - usually 3 to 10 years - used for variable rate debt where investors can “put
back” their bonds to the trustee.
Surety policies - used to replace requirement for a d/s fund.
B. Providers/Purchasers

Bond insurance provided by AMBAC, FGIC, MBIA. Usually issued for full term of the bonds.

Letters of credit provided by commercial banks (not very common any more). Often issued for
less than term of the bonds.
C. Purposes

Primary reason is for issuer to save money on d/s costs

Bonds will carry rating of the credit provider

Test: A municipality would choose to purchase bond insurance to achieve a higher credit
rating.
D. Types of Credit Enhancement and Credit Substitution
E. Factors to Consider
VI. Credit Analysis (8)
A. Role of Rating Agencies

Provide understandable measure of degree of risk of issuer’s securities.
B. Rating Process and Analysis

Less than BBB rating is considered below investment grade.

Issuer requests a rating from one or more rating agencies.

GO Bonds - 4 primary factors considered:
1) Debt mgmt. - using key financial ratios to assess ability to support existing and future
debt obligations.
2) Administrative issues - review of organization and management.
3) Financial performance - revenue and expenditure trends - adequacy of revenues.
4) Economic base - economic outlook for the issuer.

Revenue Bonds - 2 additional factors:
5) Demand fro service provided (feasibility study)
6) Review of legal documents, ration covenants, etc.

Test: Which of the following types of debt is most likely to have the highest credit rating?
General obligation bonds.
C. Information Requirements

Drafts of bond documents
Audited financial reports (3 years)
Operating and capital budgets
Written and oral presentations
Summary of all outstanding debt
Economic and demographic information
Government’s administrative structure
D. Rating Designations
AAA, AA, A
BBB

Often revenue bonds are easier to rate than GO bonds.
VII. The Bond Sale (35)
A. Bond Issuance Team (10)

Financial Advisor - works with issuer to determine:
1) Structure and timing of the issue
2) Prepare bond documents
3) Prepare rating agency presentations
4) Evaluate and select best bid
5) Close the transaction
- Can be compensated hourly, fixed fee, or % of bonds issued.

Underwriter - purchases securities from govt. and resells to investors.

Bond Counsel 1) Primary duty is to certify legal authority to issue bonds and that bonds qualify for tax
exemption.
2) Works to assure legal compliance
3) Drafts bond documents including o/s, ordinances, etc.
- Can be compensated hourly, fixed fee, or % of bonds issued.

Paying Agent / Registrar - Receives $ from issuer and makes
payments to bond holders. Maintains records of bond ownership.

Trustee contract.

Acts as fiduciary agent for bondholders to enforce terms of bond
Securities Depository - Maintains ownership records for “book entry”
bonds

Printer

Test: Which of the following is the most important responsibility of bond counsel in a bond
transaction? Provide an opinion on the validity and tax status of an issue
B. Method of Sale (3)


Competitive
Negotiated Underwriter selected early, participates in issue process, price
of bonds is negotiated.
Advantages:
1) Delegate tasks to underwriter.
2) Extensive pre-sale marketing can impact structure of bonds.
3) Flexibility in timing and structure.
Disadvantages:
1) Lack of pricing competition.
2) Difficulty in determining gross spread amount.
3) Subject to charges of favoritism in choosing u/w firm.

Private Placement

How to choose method of sale - lowest cost of debt while meeting policy objectives.
Consider:
1) Credit quality of issuer. Low credit issues may be negotiated.
2) Investor familiarity with issuer.
3) Complexity of the issue.
4) Volatility of market conditions.
5) Size of the issue - very large issues are often negotiated due to need for extensive
marketing efforts.

Test: In which of the following circumstances would an issuer be most likely to use a
competitive sale? Issuer plans to sell bonds that are well understood by the investor community.
C. Competitive Bid Process

Advantages:
1) Competition provides some assurance of lowest interest cost. Incentive for aggressive
bidding.
2) Historically lower gross u/w spreads.
3) appearance of open, fair process.

Disadvantages:
1) More difficult for issuer to respond to change in market conditions by changing date of
issue because Notice of Sale is required to be published 10-14 days prior to bid opening.
2) u/w will add a risk premium to bid.
3) Issuer has less control in selecting a particular underwriter.
D. Evaluation of Bids


True Interest Cost (TIC) - preferred method - considers time value of money.
Net Interest Cost (NIC) - Used to be used most often. NIC is average interest rate on a bond
issue. Quick to calculate, but does not consider time value of money.

Test: Which of the following is the preferred method for determining the interest cost of a bond
issue? True interest cost
E. Pricing Bonds in a Negotiated Sale (8)
F. Form and Payment of Bonds (6)

Bonds must be in registered form if maturity exceeds 1 year (federal law). Registrar keeps
names of owners for interest payments.

A securities depository can retain all physical bonds. Immobilizes actual printed bond certificates.
Or
Bonds can be issued in book entry only form. Securities depository just keeps records of
ownership and makes interest payments.
G. Documentation

Bond Resolution
- governing board authorizes issuance and sale of securities.
- describes nature of offering, terms & conditions of sale, obligations of issuer to
bondholders.
- amount, maturities, security, approval of O/S, approval of terms to underwriters, trust
indenture, appointment of trustee.

Trust Indenture
- legal contract between issuer and trustee.
- defines security, flow of funds, bond covenants, other protection of investor.

Notice of Sale
- Ad to invite underwriters to bid (bidding requirements, time of sale).
- Must be posted according to State laws.
- Published in Bond Buyer.

Bond Purchase Agreement (a.k.a. Underwriting Agreement or Contract Of Purchase)
- outlines terms, prices, and conditions of purchase
H. Preparation of the Official Statement



O/S discloses important info re: debt offering
O/S is equivalent to “Offering Circular” or “Prospectus” in corporate world
Municipal Securities Rulemaking Board (MSRB) requires O/S copy to each investor.

GFOA disclosure guidelines:
1) cover page describing key features of securities
2) introduction to O/S
3) Description of securities
4) Description of credit enhancements
5) Description of issuer
6) Debt structure
7) Basic documentation (bond indenture, resolution, etc)
8) Financial information
9) Legal matters
10) Miscellaneous

Terms and definitions:
Dated Date - Date securities begin to accrue interest. Usually 1st or 15th of month. Must be
on or before delivery date.
Maturity Date - Principal payment dates.
VIII. Other Options for Selling Bonds (5)
A. Direct Sales (Mini Bonds)
B. Private Placements




Sale of bonds by issuer directly to investors w/o a public offering.
U/Ws usually help in placing the bonds.
Reasons used:
1) faster sale
2) issue is not rated
3) limited disclosure required
Rare - only about 1% of volume of bonds issued.
IX. The Underwriting Process (9)
A. Role of Underwriter in Purchase and Sale of Bonds

Purchase securities from government issuer and resell to investors.
B. Syndicate Activities

If amount of issue is too large for one underwriting firm, or if certain firms are strong in selling to
specific types of investors.

Syndicate can be formed by underwriting firms themselves, or by the issuer.

Syndicates can have tiers
- senior managing underwriter
- co-managers
- selected based on ability to re-market bonds to specific investor groups.
- can be selected to meet issuer policies such as use of regional firms, DBE goals, etc.
C. Syndicate Compensation




U/Ws receive “gross spread” (aka “underwriter’s discount”)
Gross Spread is a % of bonds sold - expressed as $x per $1,000 bond.
Gross Spread includes 4 components:
1) Takedown - sales commission (biggeest component of gross spread)
2) Management Fee - fee paid for advice, document prep, syndicate mgmt.
3) U/W Risk - compensation for assuming risk to by and place securities.
4) Expenses - direct costs, travel, computer time, and U/W counsel (if used).
Gross Spread is included in U/W bid in a competitive sale
But is negotiated in a negotiated sale.
D. Underwriter Disclosure Requirements

SEC Rule 15c2 -12 - U/Ws must review O/S prior to agreement to purchase bonds from issuer.

Test: The Municipal Securities Rulemaking Board Rule G-37prohibits a municipal securities
dealer from:
1. underwriting a municipality’s bonds within a two-year period after making contributions to
an issuer official.
2. serving as financial advisor to a municipality within a two-year period after making
contributions to municipal officials.
3. making a contribution to an issuer official within a two-year period after a negotiated sale
transaction was conducted.
4. engaging in a negotiated transaction with an issuer within a two-year period after any
contribution was made to an issuer official.
X. Managing Outstanding Debt (14)
A. Investing Bond Proceeds

Match investment maturities to coincide with anticipated construction draw dates.

3 Investing risks:
1) Credit risk - invest in securities that may default.
2) Market risk - risk of selling prior to maturity at a loss.
3) Opportunity risk - buying at wrong interest rate levels.
B. Complying with Arbitrage Restrictions

Arbitrage is difference between yield on issuer’s tax exempt bonds and the investment income
earned on the proceeds.

Arbitrage profits come when low yield bond proceeds are invested in high yield securities.

Fed gov’t loses tax revenues from tax exempt debt. Arbitrage restrictions in place for 2 reasons:
1) Stop using debt to generate investment profits.
2) Spend bond proceeds quickly.

Rebateable arbitrage must be reported every 5 years plus final calculation with final D/S payment.
Uses a future value computation.

Test: 12. Federal arbitrage regulations are designed to achieve all of the following, EXCEPT:
preserving flexibility for state and local governments in meeting capital needs.
They ARE designed to: 1. limit the ability of state and local governments to invest tax-exempt
bond proceeds in taxable securities.
2. preventing the over issuance of tax-exempt bonds.
3. ensuring tax-exempt bond proceeds are spent in a timely manner.

Test: 13. New money, tax-exempt governmental purpose issues sold after 1985 may be
advance refunded how many times? One time
C. Assessing Refinancing Opportunities

Current refunding
- Prior bonds are paid within 90 days of issuance of refunding bonds.

Advance refunding
- Prior bonds are left outstanding until maturity or call date.
- Generally limited to one advance refunding.
- No advance refunding of “private activity bonds:.

3 primary reasons for refunding:
1) reduce interest costs (most common) - Look at when current interest rates are 2-3%
below bond rate.
2) restructure debt service
3) eliminate restrictive bond convenants

Must look at present value savings including issuance costs, call premiums, etc.
Present value of all refunding costs must be less than P.V. of interest savings.
Target 3 to 5 percent P.V. savings as % of debt being refunded.

Test:
1. For which of the following reasons would a government undertake a refunding?
A) change call provisions on outstanding debt.
B) achieve interest cost savings.
C) eliminate arbitrage liability.
D) modify restrictive bond covenants.
1. A and B
2. B and C
3. B and D
4. A, B, and D

Test: 2. The ability to call bonds away from investors is of particular value to the issuer when
interest rates have declined significantly below the coupon interest rates on outstanding bonds.
D. Providing Secondary Market Disclosure

SEC Rule 15 C 2-12
- Aftermath of default by Washington Public Power Supply System (WPPSS)
- Timely information to investors
- Underwriters must review issuer’s OS (since SEC has power over U/Ws)
- Gov’t subject to SEC antifraud rules

Test: 11. In general, governments are required to provide pertinent information about their
operations and financial condition for a bond issue: at the time bonds are issued, annually until
they are retired, and whenever there is a material change in operations or financial condition.
E. Maintaining Investor Relations Program
F. Providing Updated Information to Rating Agencies
G. Monitoring Trading Activity (Price Transparency)
H. Tax Lien Securitization of Debt
I. Dealing with Financial Emergencies, Bankruptcy, Default
XI. Leasing (8)
A. Participants in the Leasing Program

- Issuer sells COPs and uses proceeds to buy buildings from government.
- Investors buy COPs.
- Government sells buildings to get cash, then lease buildings back - lease payments serve as
d/s payments.
B. Types of Leases and Transactions
1) True or operating leases - use assets, but does not transfer ownership.
2) Tax exempt leases or lease purchase agreement (installment sales) - lease payments
include both principal and interest. Interest is tax exempt.
3) Master leases - can add additional assets to be leased (i.e. more copiers).
4) Sale-leaseback.
C. Reasons for Leasing
Debt limit ceilings
Cash flow
More efficient, cheaper
Easier, quicker
More flexible
D. Types of Lease Structures/Instruments
Direct lease
Assigned lease
Certificate of participation
Lease-rental debt
E. Legal and Financial Considerations
F. Secondary Market Securitization
Non-appropriation clause - lease payments subject to annual budget process.
Non-substitution clause - government will not acquire similar asset if lease payments are not paid.
Essential purpose clause - states the use of the asset is very important to government.
Security of interest - if government defaults, the lessor can take immediate possession of the
asset without legal contest.
Reading List (bold to re-read)
Pricing Bonds in a Negotiated Sale: How to Manage the Process
Guide to Arbitrage Requirements for Government Bond Issues (1992)
Supplement to Guide to Arbitrage Requirements for Government Bond Issues (1994)
Structuring and Sizing the Bond Issue: How to Develop and Optimal Financing Approach
Competitive v. Negotiated: How to Choose the Method of Sale for Tax-Exempt Bonds
Purchasing Credit Enhancement: How to Decide if Bond Insurance Makes Sense
Debt Issuance and Management: A Guide for Smaller Governments
Tax Exempt Financing: A Primer
An Elected Official’s Guide to Debt Issuance
A Guide for Preparing a Debt Policy
Local Government Finance: Concepts and Practices
Chapter 14 “Debt Policies and Procedures”
Chapter 15 “Debt Market and Instruments”
Chapter 16 “Leasing and Service Contracts”
Glossary of Municipal Securities Terms
GFOA Recommended Practices (section devoted to Debt Management)
Selected articles from Government Finance Review
Debt Management - Sample Examination Items
1. For which of the following reasons would a government undertake a refunding?
A) change call provisions on outstanding debt.
B) achieve interest cost savings.
C) eliminate arbitrage liability.
D) modify restrictive bond covenants.
1. A and B
2. B and C
x3. B and D
4. A, B, and D
2. The ability to call bonds away from investors is of particular value to the issuer when
1. cash for coupon payments is unavailable.
x2. interest rates have declined significantly below the coupon interest rates on outstanding bonds.
3. interest rates have increased significantly above the coupon interest rates on outstanding bonds.
4. an issuer is prohibited from retaining arbitrage profits.
3. Which of the following is most likely to be a provision for the issuance of certificates of
participation?
1. Yield restriction requirement for invested proceeds.
x2. Non-appropriation clause.
3. Full faith and credit pledge.
4. Voter approval requirement.
4. A municipality would choose to purchase bond insurance to achieve
x1. a higher credit rating.
2. less restrictive bond covenants.
3. an unqualified auditor’s opinion.
4. a lower call premium.
5. Which of the following is the preferred method for determining the interest cost of a bond issue?
x1. True interest cost
2. Net interest cost
3. Gross interest cost
4. Premium interest cost
6. In which of the following circumstances would an issuer be most likely to use a competitive sale?
1. Issuer plans to sell bonds with a rating that is below investment grade.
x2. Issuer plans to sell bonds that are well understood by the investor community.
3. Issuer plans to sell bonds with a complex security structure.
4. Issuer plans to sell bonds to a small group of sophisticated investors.
7. Two elements of risk that issuers should consider when issuing variable rate demand obligations
are:
A) exchange risk.
B) reversal risk.
C) interest rate risk.
D) remarketing risk.
1. A and B.
2. A and C.
3. B and D.
x4. C and D.
8. A serial bond structure is one in which
1. the interest rate for each maturity is reset periodically.
2. principal and interest payments are deferred for several years into the future.
x3. a portion of the issue’s aggregate par value matures each year.
4. principal is paid in a lump sum when the issue is retired.
9. TANs, RANs, TRANs, BANs and GANs are all types of
x1. municipal note obligations.
2. investment instruments for debt service reserve funds.
3. revenue bonds.
4. lease structures.
10. The Municipal Securities Rulemaking Board Rule G-37prohibits a municipal securities dealer from
1. underwriting a municipality’s bonds within a two-year period after making contributions to an issuer official.
2. serving as financial advisor to a municipality within a two-year period after making contributions to municipal
officials.
3. making a contribution to an issuer official within a two-year period after a negotiated sale transaction was
conducted.
x4. engaging in a negotiated transaction with an issuer within a two-year period after any contribution was
made to an issuer official.
11. In general, governments are required to providepertinent information about their operations and
financial condition for a bond issue
1. only at the time bonds are issued.
2. at the time bonds are issued and then annually until they are retired.
3. at the time bonds are issued and then every five years until they are retired.
x4. at the time bonds are issued, annually until they are retired, and whenever there is a material change in
operations or financial condition.
12. Federal arbitrage regulations are designed to achieve all of the following, EXCEPT
1. limiting the ability of state and local governments to invest tax-exempt bond proceeds in taxable securities.
2. preventing the over issuance of tax-exempt bonds.
3. ensuring tax-exempt bond proceeds are spent in a timely manner.
x4. preserving flexibility for state and local governments in meeting capital needs.
13. New money, tax-exempt governmental purpose issues sold after 1985 may be advance refunded
how many times?
1. Never
x2. One time
3. Two times
4. No limit
14. Which of the following is the most important responsibility of bond counsel in a bond transaction?
1. Provide an opinion on the credit quality of an issue
x2. Provide an opinion on the validity and tax status of an issue
3. Design a structure for the issue an market bonds to investors
4. Evaluate the pricing of an issue based on market conditions
15. All of the following are associated with a revenue bond transaction, EXCEPT a
x1. full faith and credit pledge.
2. Debt service reserve requirement.
3. Debt service coverage test.
4. Trust indenture.
16. Which of the following types of debt is most likely to have the highest credit rating?
1. Sales tax revenue bonds
2. Tax increment bonds
x3. General obligation bonds
4. Lease revenue bonds