Chapter 5 Practice Question Answers
- 1. Answer: B. Arbitrage refers to the interest income issuers of tax-exempt bonds may be able to earn by investing bond proceeds obtained from the sale of tax-exempt bonds in higher yielding taxable securities. The purpose of the federal arbitrage rules is to prohibit the excessive and premature issuance of tax-exempt bonds so that governments will not benefit from the investment of bond proceeds in income-producing securities.
- 2. Answer: C. The private loan financing test says that a bond is a private activity bond if more than the lesser of $5 million or 5% of its proceeds is used to provide a loan to a private business. Because 5% of $40,000,000 is less than $5 million, then Leadville must loan no more than 5%, that is, no more than $2 million.
- 3. Answer: A. Private activity bonds and Build America Bonds are usually taxable with some exceptions. AMT bonds are a special kind of private activity bond that are also taxable under the AMT. Bank qualified bonds are a class of bank bonds that are always exempt.
- 4. Answer: C. The AMT or alternative minimum tax is a federal income tax on wealthy taxpayers that is separate from the regular income tax calculation. It is imposed only if AMT exceeds regular federal income tax. No deduction is allowed for state and local taxes or miscellaneous itemized deductions when calculating AMT. However, so-called tax preference items in the regular income tax, such as interest on private activity bonds as well as state and local taxes, must be added back to income when calculating AMT.
- 5. Answer: A. The de minimis amount is 0.25% of par per year, which in this case is $12.50, or $125 over the ten-year life of the bond. Since the discou