General obligation bonds (G.O. bonds) are a type of municipal bond that is secured by the full faith and credit of the issuing government entity. These bonds are backed by the issuer’s power to tax residents, which means they are generally regarded as low-risk investments. Unlike revenue bonds, which are supported by revenue from specific projects or sources, general obligation bonds rely on the broader capacity of the issuing entity to meet debt obligations through taxation.
Types of General Obligation Bonds
Unlimited Tax General Obligation Bonds (UTGO)
These bonds are secured by the unlimited taxing power of the issuing government. This means the issuer may raise property taxes to any level necessary to meet debt service requirements.
Limited Tax General Obligation Bonds (LTGO)
These bonds are secured by a pledge to levy property taxes up to a certain limit. The limitation makes LTGO bonds slightly riskier than UTGO bonds but still relatively secure.
Special Considerations
Creditworthiness
The creditworthiness of the issuing government significantly impacts the risk and interest rates associated with G.O. bonds. Entities with higher credit ratings, such as AAA-rated municipalities, generally issue bonds with lower interest rates.
Tax-Exempt Status
Interest earned on general obligation bonds is often exempt from federal income tax and sometimes state and local taxes, depending on the issuer and the investor’s residency.
Comparison with Revenue Bonds
General obligation bonds differ from revenue bonds in terms of security and risk:
- Revenue Bonds: Secured by specific revenue sources such as tolls from a highway or fees from a municipal utility. Generally regarded as higher-risk compared to G.O. bonds because they depend on the revenue of specific projects.
- G.O. Bonds: Secured by the issuer’s broad power to tax, making them less dependent on the success of particular projects.
Historical Context
The use of general obligation bonds dates back to the 19th century when municipalities began issuing bonds to finance public works. Over time, G.O. bonds have become a crucial tool for funding infrastructure, schools, and other public services.
Applicability
Investors seeking low-risk options often include G.O. bonds in their portfolios due to their relative safety and potential tax advantages. Similarly, municipalities use these bonds to finance essential public projects without tying the repayment to specific revenue streams.
Related Terms
- Municipal Bonds: A broader category that includes G.O. bonds and revenue bonds.
- Revenue Bonds: Bonds secured by specific revenue sources.
- Tax-Exempt Bonds: Bonds that offer interest income free from federal income tax.
FAQs
Are General Obligation Bonds Risk-Free?
How Can Investors Purchase General Obligation Bonds?
Do General Obligation Bonds Offer Better Returns Compared to Revenue Bonds?
References
- Fabozzi, Frank J., and T. Dessa Fabozzi. “The Handbook of Municipal Bonds.” Wiley, 2008.
- Kidwell, David S. et al. “Public Financial Management.” Houghton Mifflin, 2002.
Summary
General obligation bonds are a fundamental component of municipal finance, providing a secure investment backed by the issuing government’s taxing power. They offer an attractive option for risk-averse investors and serve as a reliable method for municipalities to fund various public projects. This security, combined with potential tax benefits, makes G.O. bonds a staple in the realm of public finance and investments.
