Financing public projects often involves the issuance of bonds by governments and municipalities. Among the various types of bonds, general obligation (GO) bonds and revenue bonds are widely used. These bonds play a crucial role in funding public initiatives, but they have distinct features regarding repayment sources and investor security. In this article by Provident Financial Planning, we will delve into the dissimilarities between general obligation bonds and revenue bonds, providing insights into their characteristics, advantages, and considerations for potential investors.
General Obligation Bonds:
General obligation bonds are issued by government entities, such as states, cities, or counties, to finance a variety of public projects, including infrastructure improvements, schools, and public facilities. These bonds are backed by the full faith, credit, and taxing power of the issuer. Key features of general obligation bonds include:
- Repayment Source: General obligation bonds are repaid through a combination of general tax revenues, such as property taxes, income taxes, or sales taxes. This broad revenue base provides a high level of security for bondholders.
- Risk Profile: General obligation bonds are considered low-risk investments because they have the full backing of the issuing government entity. In the event of a financial crisis or economic downturn, the government entity has the authority to increase taxes or allocate resources to meet its debt obligations.
- Creditworthiness: The creditworthiness of general obligation bonds is typically evaluated based on the issuer's financial strength, including its tax base, revenue streams, and overall fiscal health. Higher-rated bonds offer lower yields but are generally considered safer investments.
Revenue bonds, on the other hand, are issued to finance specific revenue-generating projects, such as toll roads, airports, water and sewer systems, or public utilities. Unlike general obligation bonds, revenue bonds are secured by the revenue generated by the project being financed. Key features of revenue bonds include:
- Repayment Source: Revenue bonds are repaid from the revenue generated by the specific project or facility being financed. For example, toll revenues pay for toll road revenue bonds, and water bill payments support water and sewer system revenue bonds.
- Risk Profile: The risk associated with revenue bonds is directly tied to the success and revenue-generating capacity of the underlying project. If the project fails to generate sufficient revenue to cover debt service obligations, bondholders may face a higher risk of default.
- Creditworthiness: Creditworthiness of revenue bonds is assessed based on the strength and stability of the revenue source. Factors such as demand for the service or facility, competition, and regulatory environment play a significant role in evaluating the creditworthiness of revenue bonds.
Comparison and Considerations:
While both general obligation bonds and revenue bonds offer investment opportunities, there are important factors to consider:
- Risk and Security: General obligation bonds are generally considered lower risk due to their broader revenue base and the taxing power of the issuer. Revenue bonds are more closely tied to the success of the specific project or facility.
- Yield and Return: Revenue bonds often provide higher yields to compensate for the higher risk associated with the revenue source. General obligation bonds typically offer lower yields but provide greater security.
- Investor Preferences: Investors with a lower risk tolerance and a desire for stable income may prefer general obligation bonds. Investors seeking potentially higher returns and willing to assume greater risk may be attracted to revenue bonds.
General obligation bonds and revenue bonds are distinct types of municipal bonds with different repayment sources and risk profiles. General obligation bonds rely on the full faith, credit, and taxing power of the issuing government entity, while revenue bonds are backed by revenue generated from specific projects.
It is important to evaluate creditworthiness, assess risk levels, and consult with a financial advisor about investing in these bonds. At Provident Financial Planning, we use individual bonds to manage cashflow needs for clients in retirement to secure their future and minimize short term market volatility.
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