Municipal underwriting_PassPerfect Breakdown

Hi! I have two Qs form passperfect I’d like to run by us here. I hope that’s alright :slight_smile: I realize I am needing perspective/ achievable breakdown on these…thank u so much in advance.

Q1. A municipality issues a 30-year zero-coupon bond at deep discount. The bond is callable at 103. The bond is called in Year 10 when its current accreted value is $500. The bondholder will receive:

B103% of $500
D103% of $1,000
The best answer is B.

If a zero-coupon bond is called prior to maturity, it is called at the current accreted value plus any call premium specified in the bond contract.

Q2. A municipal bond dealer quotes 10 year 4% Revenue bonds at 95 1/2 - 97. The dealer’s [spread] per $1,000 is:

|III||15 basis points|
|IV||150 basis points|

AI and III
BI and IV
DII and IV

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Hi @Terrence_Boyer - I’m glad to help!

For Q1 - Zero coupon bonds can be callable just like typical coupon-paying bonds. However, they are callable in a slightly different way. Here’s the snippet we have about this in our materials:

Zero coupon bonds can be callable as well, but not callable at the redemption (par) value. For example:

10 year, zero coupon bond sold at 70 callable at 102 after 5 years

This zero coupon bond is callable at 102% of its “accreted” value after 5 years. We cover accretion in detail in a future chapter, but assume it means the “book value” of the bond. This zero coupon bond was sold at 70% of its $1,000 par value, or $700. If a bond is sold at a $300 discount and matures in 10 years, it’s like the bond’s “book value” increases by $30 annually ($300 discount / 10 years). After one year it should be worth around $730, after two years it should be worth around $760, and so on.

At the 5 year mark, this bond should maintain an accreted value of $850 ($700 original purchase price + (5 years x $30 annual accretion)). If the bond is called, it will be called at 102% of $850, which is $867. The key is knowing a zero coupon bond is callable at its accreted value, not the $1,000 par value.

Hopefully this shows why B is the best answer.

For Q2 - A market maker spread represents the difference between the bid and the ask price. We cover this concept thoroughly in this chapter.

The easiest way to answer this question is to first convert the bid and ask prices (95 1/2 - 97) into actual prices. While corporate bonds are the ones typically quoted in fractional form in 1/8ths, some municipal revenue bonds are quoted this way as well. This chapter goes over how to convert these quotes into actual prices.

95 1/2 = $955
97 = $970

If we converted the original bid/ask (95 1/2 - 97) using the prices above, the quote should appear as:

$955 - $970

Getting this far determines answer choice II must be correct. Last, we must determine if III or IV is correct.

Basis points are often used as a coded way of referencing percentages. As we teach in this chapter:

You may encounter basis points on the exam, and there are a few ways to remember what a basis point is:

  • 1 basis point = 0.01%
  • 100 basis points = 1.00%

Getting back to the original quote:

95 1/2% of par - 97% of par

When a quote like ‘97’ is provided, it really is saying the bond is trading at “97% of its par value.” Written another way, we could see it like this:

95.5% - 97.0%

The difference between the two quotes is 1.50% of par. If 1% is equal to 100 basis points, then 1.50% must be equal to 150 basis points.

Therefore, the answer to Q2 must be II and IV.


Thank you @brandonrith These are chapters I have not gone over- this makes sense. Thank you!!

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