Updated July 17, 2023
What is General Obligation Bond?
A general Obligation bond is a kind of municipal bond issued by the government for raising funds for projects related to the welfare of its public and is guaranteed by both operating revenue earned from various projects and the tax revenue. Therefore, the repayment is mostly made on time, and the default rate is very low.
Explanation
These bonds are issued by the local and state authorities to raise funds for public projects that are for the welfare of the public, like projects related to the construction of roads and bridges, public parks, government schools, etc., the repayment of General obligation bond is guaranteed by both the revenues, i.e., tax revenue and operating revenue. So the chances of default in repayment of the amount are very rare. General obligation bonds are primarily issued for funding public projects. In some situations, chances are there that default in repayment of the amount could be there, but mostly the repayments are made even if the projects under consideration fail.
How Does it Work?
The municipality launched the scheme of General obligation bonds to fulfill the monetary needs of various public projects requiring huge funds. Government sanctions various public projects for the benefit of society, which requires a huge amount of funds. Now at the time of sanctioning of the project, if the municipalities are short of funds, then they raise money by issuing a bond with the project’s name, and the investors purchases such bonds from the issuer that provides the funds to the concerned government authorities to start and end the work of project well on time.
Further, the issuer repays these bonds without any delay and with interest. In some rare situations, there are chances that there is a default in repayment of the amount but mostly, the repayments are made even if the projects fail. In some situations, the municipalities may ask for higher taxes to compensate for the loss of revenue. The investor’s money is at a very lower or negligible risk when they invest their money in these bonds, and the credit ratings of these bonds are very strong.
Types of General Obligation Bond
The General Obligation bonds are mainly of two types: Limited tax General obligation bonds and unlimited tax General Obligation bonds. These two types of bonds are discussed below-
- Limited Tax: In the case of a limited tax General obligation bond, the municipalities are allowed to raise property taxes if it is essential to meet the current debt obligations, but the statutory limit binds the increase in taxes. Moreover, in this kind of bond, approval from taxpayers is not generally needed.
- Unlimited Tax: In the case of unlimited tax-general obligation bonds, the taxpayer’s approval is required. The unlimited tax-GO obligation is almost similar to the limited tax- General obligation bonds but here, there is no limit on the increase of property tax. Even the property tax can rise 100%, but the taxpayer’s approval is required.
How to Buy General Obligation Bond?
Firstly the investor should contact the broker. Although, in rare situations, the bond can be purchased from the municipality directly, most of the bonds are sold in the secondary market through brokers. Before purchasing the bond, investors should research the bond’s credit rating and financial viability. The higher rating indicates the timely repayment of the bond amount. Moreover, the investor must check out the interest payment dates, the bond’s maturity date, and the other purchase requirements. After checking the above requirements, the investor can purchase the bond through a broker by paying the markup or commission on the bond price.
Advantages
The advantages of general obligation bonds discuss as under-
- The general obligation bond is safe as the default risk is very low, so it is a good option for investment.
- The tax-exempt bond encourages investors to spend their money on the bonds.
- If there is a default in the repayments, the investors can get their payments from the taxation authorities, as the municipalities can call for more taxes to clear their dues.
- From the municipality’s point of view, the bond helps them to raise money for public projects.
- When the project cannot complete in abnormal conditions or deficiencies, the municipality has to clear its dues from the revenue generated.
Disadvantages
The disadvantages of General obligation bonds discuss as under-
- The return rate is comparatively lower than the other kind of bonds.
- Proper analysis and research are required before investing in this kind of bond. It is important to check whether the bond is tax-free and whether tax authorities are paying it off in case of default.
- Sometimes the repayment of the bond amount is very difficult, although the payments do not depend upon the revenues from the ongoing public project.
- In the general obligation bond, the investors have to decide whether they want a risk-free investment or a good rate of return.
Conclusion
Thus, the general obligation bond is the government-aided bond that the local or state government issues to raise funds to complete public welfare projects such as constructing roads, sewer lines, public parks, schools, etc. This bond is safe as there are negligible chances of default, and the investors get their payments back even if the concerned project fails.
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