What is General Obligation Bond?
General Obligation Bond is a type of bond which is supported or guaranteed by agencies like municipalities wherein repayments are prompt and have very low default rates as municipals are authorized by the government to increase the tax amount which is receivable from the public to pay off the dues and debts associated with the repayments to the investors.
These types of bonds are popular in the US and were introduced to finance the public projects in the country, for example, bridges, roads, repair and maintenance of big public projects, etc. In this, the municipality will not face any difficulties because the municipality makes the call for more taxes at the time of any fiscal shortage, although the revenues of the municipalities are very well maintained, and the chances of default are very rare. There are many mutual funds and fund transfer exchanges which facilitate the process of this scheme somewhat easy for the investors.
How Does it Work?
General Obligation Bond is a scheme that is introduced by the municipality to complete certain public projects which require a huge amount of capital. For the upliftment of the society, the government sanctions some projects, and at times the municipalities are short with the capital to start and finish the project on time. The municipalities then issue these bonds in the name of that project, and the investors of the project buy the bonds from the municipalities and provide them the capital to start and finish the project. These bonds are guaranteed by the municipalities.
The repayment on these bonds is also very prompt and with interest. There are very rare situations when the municipalities default, and the investor’s repayment is delayed or denied. The projects may fail, but the repayments of the investors are generally cleared. There are situations when the revenues are fallen short, and then the municipalities have asked for taxes to compensate for the same. Thus the process and the repayment of these types of bonds are very prompt, and the investors are at the lowest risk while investing their money on these bonds, and also, the credit rating agencies rank this bond as strong.
Types of General Obligation Bond
There are two types – limited tax and the unlimited tax
- Limited Tax: In this, the municipality can raise the property taxes but up to a certain level, and the approval from taxpayersTaxpayersA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws. is not necessary.
- Unlimited Tax: Here, the taxpayer’s approval is required. There is also no limit in increasing the property tax to clear the debt of the municipality.
How to Purchase General Obligation Bonds?
First of all, the investors are required to take some pain to research the market and the credit rating agencies before investing their money in any bonds. There are two ways by which an investor can purchase the general obligation bond. It is available in the municipality offices, and also the bonds can be purchased from the brokers. The brokers sell the bonds in the secondary market and charge some commission out of it.
General Obligation Bonds vs. Revenue Bonds
In the case of General Obligation Bond, the repayment of principal and interest is made from all the revenues, including the taxes at the time of default like situation, whereas in revenue bondsRevenue BondsRevenue bonds are bonds issued by municipal corporations where the revenue from income-producing projects such as toll bridge, highway, sewer facilities, airport construction, roads, local stadium are used in repaying the debt obligation (both interest and principal component)., the repayments are generally made from the operating revenues only. The repayment is guaranteed in general obligation bond, whereas in the case of Revenue bonds, the repayment is dependent on operating revenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations., and thus it is sometimes risky to get the repayments on time.
- This Bond is considered to be very safe and a good investment option for investors.
- It is tax-exempt; therefore, it encourages the investors to invest their money in these types of bonds.
- In case of any default, the investors will get the entire repayments from the tax authority since the municipalities have the right to call for more taxes than usual to pay the dues.
- These bonds are issued in the market, and the capital is being raised on a large scale; thus, it encourages the investors to invest in general obligation bonds.
- This also helps the municipalities to complete the project by issuing the bonds in the market.
- In the worst condition or any fiscal deficiency when the project fails that time, the municipal must clear the debts from the entire revenue.
- They provide fewer returns than any other bond present in the market.
- In this, the investors have to choose between the returns or risks associated with the bonds.
- It becomes very important for the investors to research for the bonds before investing since many general obligation bonds are not tax-free, and also the tax authority may not pay for the dues.
- The repayment in such a bond can be very difficult, although it doesn’t depend upon the operating revenues of the ongoing projects.
It is a government-aided bond issued to the public at large to raise capital in case of shortage. The big investments made for the public welfare are sometimes arranged by issuing a general obligation bond. It is a safe option for any investor, but the returns are comparatively low here. In this repayment process, the investors will get the principal and the interest repaid on time. In the case of defaults, the municipals are authorized by the government to increase the tax amount, which is receivable from the public to pay off the dues and debts associated with the repayments to the investors.
This has been a guide to what is General Obligation Bond and its definition. Here we discuss how does general obligation bond work with its types, benefits, and limitations. You may refer to the following articles to learn more about finance –