Dive into municipal securities, discovering General Obligation (GO) bonds, revenue bonds, and more to understand their risks and benefits in finance.
On this page
Municipal securities are debt instruments issued by states, municipalities, or counties to finance public projects. In Chapter 6, Part II, of Understanding Products and Their Risks, we delve into the essential aspects of municipal bonds, explaining their types, funding sources, and special considerations. This guide aims to prepare you for the FINRA Securities Industry Essentials® (SIE®) Exam by offering clear explanations, illustrative examples, and interactive quizzes.
General Obligation (GO) Bonds
What are General Obligation Bonds?
General Obligation bonds are municipal bonds supported by the full faith and credit of the issuing municipality. Unlike revenue bonds, which rely on specific revenue streams, GO bonds are backed by the taxing power of the issuer. They are often used to fund projects that serve the public interest, such as schools, roads, and parks.
Key Characteristics:
Tax Backing: GO bonds are secured by the issuer’s ability to levy taxes.
Creditworthiness: A municipality’s financial condition impacts the bond’s credit rating.
Voter Approval: Issuance often requires voter approval.
Example: Building a New School
A city decides to build a new school and issues GO bonds to fund the construction. The repayment comes from property taxes collected within the city. Because these bonds use tax revenue, they often require public approval via vote.
graph TB
A[Tax Revenue] --> B[General Fund]
B --> C[Repayment of GO Bonds]
C --> D[School Construction]
Summary Points:
GO bonds utilize tax revenues for repayment.
They typically provide more stable security for investors.
Issuance may depend on public support.
Revenue Bonds
Exploring Revenue Bonds
Revenue bonds finance specific projects and are repaid using the income generated by those projects. Unlike GO bonds, they don’t rely on tax revenue but on user fees, tolls, or lease payments.
Key Characteristics:
Project-Specific Repayment: Tied to the success of a revenue-generating project.
Higher Risk: Potential for higher yields due to repayment uncertainty.
No Tax Requirement: Doesn’t necessitate voter approval or tax levies.
Example: Building a Toll Bridge
Suppose a county builds a toll bridge using revenue bond financing. The tolls collected from vehicles crossing the bridge repay the bondholders.
graph TB
A[Toll Collections] --> B[Revenue Fund]
B --> C[Repayment of Revenue Bonds]
C --> D[Toll Bridge Project]
Summary Points:
Revenue bonds hinge on the success of specific projects.
They offer potentially higher yields compensating for increased risk.
Provide a funding solution without impacting tax rates.
Special Types of Municipal Bonds and Short-Term Obligations
Municipal securities encompass diverse bond types catering to specialized funding needs or shorter timelines.
Special Types of Bonds:
Industrial Development Bonds (IDBs): Issued on behalf of private sector enterprises and repayable through leases or loan payments.
Private Activity Bonds: Used for private entities and subject to Alternative Minimum Tax (AMT).