General Securities Sales Supervisor (Series10) Practice Exam

What is a key feature of a pre-refunded municipal bond?

1. Redemption occurs at any price after the call date

2. U.S. Government securities cover the call price

3. Interest rates must be higher than old debt

4. The call price increases with each interval

The correct answer is: U.S. Government securities cover the call price

A pre-refunded municipal bond is a type of bond that has been refinanced by issuing a new bond. The key feature of a pre-refunded bond is that it is secured by U.S. government securities, which are placed in an escrow account to ensure that the call price can be met when the bond is callable. This setup effectively guarantees investors that they will receive both the principal and interest payments on the pre-refunded bond, even if the issuer experiences financial difficulties. By using government securities to cover the call price, the bond moves into an investment-grade category, providing a lower risk factor to investors. This security makes these bonds attractive for risk-averse investors and can also lead to a lower yield compared to other municipal bonds that are not pre-refunded. The assurance that the call price is backed by guaranteed U.S. government securities is a fundamental reason why such bonds are favored, enhancing both their safety and marketability.