What is General Obligation Bond?
General Obligation bond is a kind of municipal bond issued by the government for raising funds for the 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.
These bonds are issued by the local and state authorities to raise funds for the public projects that are in 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 of the 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 the consideration fail.
How Does it Work?
The scheme of General obligation bonds was launched by the municipality to fulfill the monetary needs of various public projects that required a huge amount of 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 repayment of these bonds is made 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 that include 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 increase in taxes is bound by the statutory limit. 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 approval of the taxpayer 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 be raised up to 100% but the approval of the taxpayer 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 the majority of the bonds are sold in the secondary market through brokers. Before purchasing the bond investor should research the credit rating and financial viability of the bond. The higher rating indicates the timely repayment of the bond amount. Moreover, the investor must check out the interest payment dates and the maturity date of the bond, 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.
The advantages of general obligation bond are discussed as under-
- The general obligation bond is safe as the risk of default is very less so it is a good option for the investment.
- The bond is tax-exempt which encourages the investors to spend their money on the bonds.
- If there is a default in the repayments then the investors can get their payments from the taxation authorities as the municipalities can call for more taxes so that they can clear their dues.
- From the municipality’s point of view, the bond helps them to raise money for public projects.
- In abnormal conditions or deficiencies when the project cannot be completed, then the municipality has to clear its dues from the revenue generated.
The disadvantages of General obligation bonds are discussed 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.
Thus, the general obligation bond is the government-aided bond that is issued by the local or state government for the purpose of raising the funds for the completion of public welfare projects such as the construction of roads, sewer lines, public parks, schools and 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.
This is a guide to the General Obligation Bond. Here we also discuss the definition and how to buy a general obligation bond. along with advantages and disadvantages. You may also have a look at the following articles to learn more –