Chapter 5 Practice Question Answers
1. Answer: C. The feasibility study, protective covenants, flow of funds, and the debt service coverage ratio will all be important factors in analyzing a revenue bond. The net overall debt per capita is an important factor when analyzing a GO bond.
2. Answer: B. The rate covenant requires an issuer to set rates or fees at levels sufficient to generate revenue at some designated threshold. This threshold should be sufficient to cover the project’s operating expenses and debt service, plus a reserve cushion.
3. Answer: C. The bond indenture is the legal document that specifies the scope and features of the revenue bond and holds the issuer to its terms. The issuer must appoint an independent trustee to protect the bondholder’s rights as stated in the indenture. This third-party trustee, usually a bank or trust company, is responsible for authenticating the bonds and assuring that the issuer complies with all of the covenants specified in the indenture.
4. Answer: A. When a municipality issues advance refund bonds, the new bonds are issued to pay off a previous issue of bonds (the refunded bonds) in advance of their call date. When this happens, the credit rating of the refunded bonds will go up. If the credit rating goes up, the yield on the bonds will typically go down.
5. Answer: B. Credit enhancement is a legally binding pledge of financial support coming from a source other than the issuer that virtually guarantees repayment of the bond and serves to improve the creditworthiness of the bond. Bonds with credit enhancements have higher credit ratings than ones without. Advance refunding, bond insurance, and letters of credit are all credit enhancements. A high debt service coverage ratio does not involve an outside source providing additional backing to the bond.
6. Answer: A. A notch is the smallest increment a rating can rise or drop. From AA, it will go down to AA- and then to A+. If the question wo