CFA Level 1: Bond Fund Manager's Comments

Evaluation of Revenue Bonds and Double Barreled Bonds

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Question

Bill Foley, CFA, manages an intermediate tax-exempt bond fund. Foley makes the following two comments about securities in his portfolio.

Statement 1:Revenue bonds usually pay a higher coupon rate than general obligation bonds.

Statement 2:Double barreled bonds are municipal securities that are exempt from both federal and state taxes.

Which of the following best evaluates Statement 1 and Statement 2?

Answers

Explanations

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A. B. C.

A

Statement 1: Revenue bonds usually pay a higher coupon rate than general obligation bonds. Statement 2: Double-barreled bonds are municipal securities that are exempt from both federal and state taxes.

To evaluate the two statements, let's analyze each statement individually:

Statement 1: Revenue bonds usually pay a higher coupon rate than general obligation bonds. This statement is generally correct. Revenue bonds are issued by state and local governments to finance specific projects or facilities, such as toll roads, airports, or hospitals. The coupon rate on revenue bonds is typically higher than that of general obligation bonds because revenue bonds are backed by the revenue generated from the specific project they are financing. The higher coupon rate compensates investors for the additional risk associated with relying on the revenue generated by the project. So, Statement 1 is correct.

Statement 2: Double-barreled bonds are municipal securities that are exempt from both federal and state taxes. This statement is incorrect. Double-barreled bonds are municipal securities that have two sources of repayment: a specific revenue stream and the general taxing power of the issuer. If the revenue stream is insufficient to meet the bond's obligations, the issuer has the authority to levy taxes to make up for the shortfall. While double-barreled bonds are backed by both a revenue stream and the taxing power of the issuer, their tax treatment is not automatically exempt from both federal and state taxes. The tax-exempt status of a bond depends on various factors, including the specific bond issue, the issuer's jurisdiction, and the applicable tax laws. Therefore, Statement 2 is incorrect.

In summary:

  • Statement 1 is correct. Revenue bonds usually pay a higher coupon rate than general obligation bonds.
  • Statement 2 is incorrect. Double-barreled bonds are not automatically exempt from both federal and state taxes.

The best evaluation of the two statements is: C. Both Statements are incorrect.

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