Definition
Municipal Certificate of Accrual on Treasury Securities (M-CATS) is a type of zero-coupon bond issued by a municipality. Zero-coupon bonds do not pay periodic interest. Instead, they are issued at a discount to their face value and are redeemed at par upon maturity. The difference between the discounted purchase price and the face value represents the interest earned by the investor.
Examples
-
City Infrastructure Project:
- A city government issues M-CATS to finance a new public transportation system. Investors buy the bonds at a discount, and upon maturity, they receive the full face value, which helps the city fund the project without periodic interest payments.
-
School District Expansion:
- A school district issues M-CATS to raise funds for building new schools. These bonds are attractive to investors looking for long-term appreciation and municipalities looking to postpone interest payments.
Frequently Asked Questions
What is the primary benefit of M-CATS for municipalities?
The primary benefit for municipalities is the ability to raise funds without having to make periodic interest payments, thus reducing cash flow burdens until the bond matures.
How do investors benefit from M-CATS?
Investors benefit from purchasing the bonds at a discount and receiving the face value at maturity, essentially earning interest over the life of the bond through its price appreciation.
Are M-CATS risk-free?
No investment is entirely risk-free. While M-CATS issued by municipalities generally have lower default risk, they are still subject to the issuer’s creditworthiness and economic conditions influencing municipal revenues.
How are M-CATS taxed?
The interest earned on the difference between the purchase price and the face value at maturity is typically tax-exempt at the federal level and may be exempt from state and local taxes depending on the issuer’s location.
Can M-CATS be sold before maturity?
Yes, M-CATS can be sold in the secondary market before maturity. Their price fluctuates based on interest rates and the credit quality of the issuer.
- Zero-Coupon Bond: A bond that does not pay periodic interest and is issued at a discount to its face value.
- Municipal Bond: A bond issued by a state, municipality, or county to finance its capital expenditures.
- Treasury Securities: Debt instruments issued by the U.S. Department of the Treasury to fund government spending.
Online References to Online Resources
Suggested Books for Further Studies
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Municipal Bond Markets: Causes and Consequences” by Andrew Ang
Fundamentals of Municipal Certificate of Accrual on Treasury Securities: Finance Basics Quiz
### What type of bond is an M-CATS?
- [ ] Fixed-coupon bond
- [ ] Inflation-linked bond
- [x] Zero-coupon bond
- [ ] Variable-rate bond
> **Explanation:** M-CATS is a zero-coupon bond, meaning it does not pay periodic interest and is issued at a discount to its face value.
### How do investors earn interest from M-CATS?
- [ ] Through periodic interest payments
- [ ] Through dividends
- [x] By the difference between the purchase price and the face value at maturity
- [ ] By owning a portion of municipal projects
> **Explanation:** Investors earn interest by purchasing the bond at a discount and receiving the face value at maturity.
### What makes M-CATS attractive for municipalities?
- [ ] High-interest payments
- [x] No periodic interest payment requirement
- [ ] Short-term investment horizon
- [ ] Convertibility into equity
> **Explanation:** M-CATS are attractive for municipalities because they do not require periodic interest payments, easing cash flow management.
### Are M-CATS tax-exempt?
- [x] Interest is typically tax-exempt at the federal level and may be exempt from state and local taxes.
- [ ] Interest is always taxable at both federal and local levels.
- [ ] Only the principal is tax-exempt.
- [ ] Interest is tax-deferred until maturity.
> **Explanation:** The interest earned from M-CATS is typically tax-exempt at the federal level and may be exempt from state and local taxes, depending on the issuer's location.
### What is the key risk associated with investing in M-CATS?
- [x] Credit risk of the issuing municipality
- [ ] Fluctuations in dividend payouts
- [ ] Currency exchange risk
- [ ] Commodity price volatility
> **Explanation:** The key risk is the credit risk of the issuing municipality, which could impact their ability to repay the bond at maturity.
### Can M-CATS be sold before they mature?
- [x] Yes, they can be traded in the secondary market.
- [ ] No, they must be held until maturity.
- [ ] Only if the municipality allows early liquidation.
- [ ] Only during specific periods designated by the issuer.
> **Explanation:** M-CATS can be sold in the secondary market before they mature, and their prices will fluctuate based on market conditions.
### What happens to the price of M-CATS if interest rates rise?
- [ ] The price rises
- [x] The price falls
- [ ] The price remains the same
- [ ] The price becomes volatile
> **Explanation:** The price of M-CATS typically falls when interest rates rise, as the fixed-rate nature of the bonds becomes less attractive relative to new issues.
### What is a common use of funds raised through M-CATS by municipalities?
- [x] Funding public infrastructure projects
- [ ] Paying off existing debt
- [ ] Direct distribution to residents
- [ ] Investing in the stock market
> **Explanation:** Municipalities commonly use funds raised through M-CATS for public infrastructure projects, such as transportation systems, schools, and utility upgrades.
### Is the whole interest from M-CATS received at the end taxable?
- [ ] Yes, it is fully taxable.
- [ ] Only partially taxable based on holding period.
- [x] Generally tax-exempt at the federal level.
- [ ] Tax-exempt if held within a tax-advantaged account.
> **Explanation:** The significant interest earned on M-CATS is generally tax-exempt at the federal level, which is one main attraction of these bonds.
### Are M-CATS suitable for investors looking for regular income?
- [ ] Yes, they provide regular coupon payments.
- [x] No, they do not provide periodic interest payments.
- [ ] Yes, they deliver regular dividend payments.
- [ ] They provide regular distributions through special dividends.
> **Explanation:** M-CATS are not suitable for investors looking for regular income as they do not provide periodic interest payments; they are purchased at a discount and held until maturity.
Thank you for exploring the intricacies of Municipal Certificate of Accrual on Treasury Securities (M-CATS) through our comprehensive guide and engaging finance basics quiz. Keep enhancing your knowledge in the financial markets!
