GO and Revenue Bonds on the Series 7 Exam
Municipal bonds are ones issued by state governments, local governments, or U.S. territories. Municipalities may issue many types of municipal bonds, but the two main types are GO (general obligation) bonds and revenue bonds.
Why should an investor not trade municipal GO bonds short?
A. because they are usually thin issues
B. because municipal securities do not trade on an exchange
C. because MSRB rules prohibit the short selling of municipal bonds
D. because the SEC prohibits the short selling of municipal bonds
Answer: A. because they are usually thin issues
Remember, when investors sell a security short, they’re borrowing securities for immediate sale in the market. Short sellers must cover their short positions by purchasing the securities in the market so that they can be returned to the lender.
The problem with selling any municipal securities short is that typically they’re thin issues and don’t have national interest. As such, there are no good securities to sell short because it would likely be difficult for investors to cover their short positions.
A municipality decides to call its general obligation bonds due to mature in 2022 and to finance the call by issuing bonds with a maturity date of 2035. This is known as
B. advance refunding
Answer: D. refunding
Refunding is when an issuer issues new bonds and uses the proceeds to call outstanding bonds. Pre-refunding or advance refunding is when an issuer issues new bonds a long time prior to the call date of existing bonds to take advantage of low interest rates.
The money received is held in an escrow account and invested in U.S. government securities until the existing bonds can be called. Because the money is there to pay off the bondholders, pre-refunded bonds are typically rated AAA.
Which of the following is NOT a source of funding for municipal revenue bonds?
C. property taxes
D. user fees
Answer: C. property taxes
Property taxes (ad valorem taxes) are the largest source of funding for municipal general obligation (GO) bonds, not revenue bonds.