What is a General Obligation Bond?

Explanation

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. However, the revenues of the municipalities are very well maintained, and the chances of default are very rare. Many mutual funds and fund transfer exchanges facilitate this scheme’s process somewhat easier for the investors.

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How Does it Work?

A 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 society, the government sanctions some projects, and at times the municipalities are short of 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. The municipalities guarantee these bonds.

The repayment on these bonds is also very prompt and with interest. There are 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 fall short, and 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 in 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 to a certain level, and 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.read more is not necessary.Unlimited Tax: Here, the taxpayer’s approval is required. There is also no limit to increasing the property tax to clear the municipality’s debt.

How to Purchase General Obligation Bonds?

There are two ways by which an investor can purchase the general obligation bond. First, the investors must take some pain to research the market and the credit rating agenciesCredit Rating AgenciesCredit rating agencies (CRAs) evaluate and rate the creditworthiness of debt securities and their issuers, including companies and countries.read more before investing their money in any bonds. It is available in the municipality offices, and also the bonds can be purchased from brokers. The brokers sell the bonds in the secondary marketSecondary MarketA secondary market is a platform where investors can easily buy or sell securities once issued by the original issuer, be it a bank, corporation, or government entity. Also referred to as an aftermarket, it allows investors to trade securities freely without interference from those who issue them.read more and charge some commission.

General Obligation Bonds vs. Revenue Bonds

In the case of a General Obligation Bond, the repayment of principal and interest is made from all the revenues, including the taxes at the time of default, 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).read more, the repayments are generally made from the operating revenues only. The repayment is guaranteed in a general obligation bond. In contrast, 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.read more, and thus it is sometimes risky to get the repayments on time.

Benefits

  • This Bond is considered very safe and a good investment option for investors.It is tax-exempt; therefore, it encourages investors to invest 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 bonds in the market.In the worst condition or any fiscal deficiency, when the project fails that time, the municipality must clear the debts from the entire revenue.

Limitations

  • They provide fewer returns than any other bond present in the market.In this, the investors must choose between the returns or risks associated with the bonds.It becomes very important for the investors to research the bonds before investing since many general obligation bonds are not tax-free, and the tax authority may not pay the dues.Repaying such a bond can be very difficult, although it doesn’t depend upon the operating revenues of the ongoing projects.

Conclusion

It is a government-aided bond issued to the public to raise capital in case of shortage. The big investments made for 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 municipalities 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 the General Obligation Bond and its definition. Here we discuss how general obligation bonds work with its types, benefits, and limitations. You may refer to the following articles to learn more about finance –

  • Exempt IncomeGuaranteed BondsGreen Bonds DefinitionSerial Bond