Municipal Trading and Taxation – Series 7 Exam
- April 1, 2025
- Posted by: 'FINRA Exam Mastery'
- Category: Finance
🧾 Municipal Trading and Taxation – Series 7 Exam
📘 Essential Guide to Munis for the Series 7 Exam
Understanding municipal securities—how they trade and their unique tax treatment—is a critical part of the Series 7 exam. Municipal bonds (“munis”) are debt securities issued by states, cities, and other local government entities. Here’s a structured review focused on what you’ll need to master for test day.
🎯 1. Trading of Municipal Securities
Where Municipals Trade:
- OTC Market:
- Most municipal securities trade over-the-counter (OTC) through a network of broker-dealers.
- Electronic Systems:
- EMMA (Electronic Municipal Market Access): A public database where muni disclosures, trade data, and pricing are available.
- Negotiated and Competitive Sales:
- Negotiated Sale: Issuer selects underwriter directly.
- Competitive Bid: Issuer solicits bids and awards to the lowest yield bidder.
Key Municipal Trade Terms:
- Firm Quote: A dealer’s commitment to buy/sell at a stated price.
- Subject Quote: An indication subject to market change.
- Nominal Quote: For informational purposes only, not firm.
- Workable Indication: An estimate of a price at which a dealer might buy or sell.
Types of Orders in Municipal Trading:
- Group Net Orders: All syndicate members benefit based on their participation.
- Designated Orders: Specified for a particular syndicate member.
- Member Orders: Placed for the benefit of an individual syndicate member.
🎯 2. Taxation of Municipal Bonds
Federal Tax Treatment:
- Interest on municipal bonds is exempt from federal income tax (in most cases).
- However, capital gains from selling a muni bond for more than its purchase price are taxable.
State and Local Taxes:
- In-State Bonds (Buying a bond issued by your own state):
- Often exempt from both state and local taxes.
- Out-of-State Bonds:
- Typically subject to the purchaser’s state income tax.
Private Activity Bonds and the AMT:
- Private Activity Bonds: Issued to fund private projects (like stadiums or airports).
- Alternative Minimum Tax (AMT):
- Interest income from these bonds may be taxable under AMT rules.
- Series 7 candidates must recognize that private activity bonds may lose full tax-exempt status for AMT-affected investors.
🎯 3. Types of Municipal Securities
| Type | Key Feature |
|---|---|
| General Obligation (GO) Bonds | Backed by full taxing power of issuer (property taxes, income taxes). Very safe. |
| Revenue Bonds | Backed by specific revenue streams (e.g., tolls, utilities). Higher risk than GO bonds. |
| Industrial Development Bonds | Revenue bonds supporting private companies. Interest may be subject to AMT. |
| Taxable Munis | Some munis are fully taxable (e.g., bonds funding pension obligations). |
| Anticipation Notes | Short-term municipal notes (TANs, RANs, BANs) to meet temporary cash flow needs. |
🎯 4. Municipal Bond Quotations
- Basis Quote: Quoted based on yield to maturity rather than price.
- Dollar Quote: Quoted as a percentage of par (e.g., 102 = $1,020).
🎯 5. Special Considerations
- Original Issue Discount (OID) Munis:
- Treated as tax-free interest income if held to maturity.
- Secondary Market Discount Munis:
- Gains are taxed as ordinary income, not capital gains, if bond purchased at a discount in the secondary market.
🚀 Summary for the Series 7 Exam
✔ Municipal bonds generally offer federal tax-exempt interest, but not necessarily capital gains exemption.
✔ In-state munis are often triple-tax-free (federal, state, and local).
✔ Know where munis trade and how to interpret basis quotations.
✔ Be alert to AMT issues with private activity bonds.
✔ Recognize the difference between general obligation bonds and revenue bonds regarding their backing and risk.
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