Table of Contents
What is a General Obligation (GO) Bonds?
General obligation bonds, commonly known as GOs, are municipal bonds that allow state and local governments to raise funds for projects that may not generate revenue directly. General obligation bonds are used to support initiatives such as the building of public schools and highways.
They are known as “general obligation” bonds because they are not secured by a specific revenue-generating project or asset. Instead, the issuer’s “full faith and credit” back them up. In simple terms, the bonds are backed by the state or local government’s authority to tax, and perhaps raise taxes, to pay bondholders. States use this ability through state income taxes and/or sales taxes. Local governments typically get funding in the form of property taxes.
How Does a General Obligation Bonds Work?
A General Obligation Bonds (GO Bond) is created by municipal or state governments issuing debt to fund public projects. Investors acquire these bonds, thereby lending money to the government. In exchange, the government agrees to repay the borrowed funds plus interest over a predetermined time.
The repayment is backed by the government’s taxing power, and there are two types of GO Bonds: Limited Tax General Obligation Bonds (LTGO) and Unlimited Tax General Obligation Bonds (UTGO). LTGO Bonds have a statutory property tax cap, whereas UTGO Bonds do not, resulting in a better repayment guarantee. The monies raised by GO Bonds are utilized for critical public infrastructure projects that benefit the community, such as schools, roads, and public buildings.
Types of General Obligation Bonds
General obligation bonds are classified into three classes, each with distinct characteristics:
Limited Tax General Obligation Bonds
These bonds are backed by a specific, restricted tax revenue stream.
The issuer agrees to use a defined tax (for example, property tax) to repay bonds, but the amount of tax levied is limited.
Unlimited Tax General Obligation Bonds
Unlike limited tax bonds, there is no limit to the taxes that can be levied to repay these obligations.
The issuer has the authority to increase taxes as needed to ensure timely bond repayment.
Double-barrelled General Obligation Bonds
These bonds have the characteristics of both general obligation and revenue bonds.
They are largely supported by a specific revenue source, but they also carry the issuer’s complete faith and credit, adding an extra degree of security to bondholders.
Also View: What is Fidelity Insurance?
Benefits of General Obligation Bonds
General Obligation Bonds (GO Bonds) provide numerous benefits to both issuers (usually government bodies) and investors. Here are some important benefits of obligation bonds:
Low Default Risk: GO Bonds are seen as relatively low-risk investments since the issuing government backs them up with its complete faith, credit, and taxation power. This backing gives high levels of security to bondholders, lowering the chance of default.
Attractive interest rates:
Because of their low risk, GO Bonds frequently carry excellent interest rates. Investors are ready to accept lower rates in exchange for the security afforded by the government guarantee.
Tax Advantages:
Interest income earned from GO Bonds is usually excluded from federal income tax and, in some situations, state and municipal taxes. This tax benefit makes them entice to investors looking for tax-efficient investment opportunities.
Funding for public projects:
Issuers use the proceeds from GO Bonds to fund public projects such as schools, roads, bridges, and other critical infrastructure. This enables governments to carry out large-scale projects without relying simply on their annual budgets.
Stable Income for Investors:
Bondholders receive regular interest payments, which provide a steady and predictable revenue source. This might be especially appealing to income-oriented investors, such as retirees wanting consistent cash flow.
Municipal Support:
GO Bonds frequently require voter approval, indicating community support for the projects they fund. This backing provides further confidence to investors about the likelihood of bond repayment.
Flexibility in the use of funds:
Unlike revenue bonds, which are connected to certain income streams, GO Bonds give issuers greater flexibility in how they use cash. Governments might use the proceeds to fund various projects based on changing priorities.
Enhanced Borrowing Capacity:
GO Bonds’ outstanding creditworthiness enables governments to access capital markets at attractive terms. This increased borrowing ability allows them to finance vital infrastructure and development projects.
Investor Diversity:
Individual investors, institutional investors, and funds looking for a well-diversified portfolio like GO bonds. Municipal bonds can help to balance out an investing portfolio.
Economic Stimulation:
GO Bonds help to boost the economy and create jobs by financing public projects. The injection of cash into communities can boost local economies, making them more robust and appealing to enterprises.
People also like: What is an Industrial Product? Definition, Characteristics, Types, and Examples
Risks Associated with General Obligation Bond
Despite having several benefits, general obligation bond also possess different risk such as:
Credit Risk
Although general obligation bonds are backed by the issuer’s full faith and credit, there is still the possibility that the issuer will fail to meet its obligation to pay interest and principal.
Economic downturns decreased tax collections, and bad fiscal management all have the potential to impair the issuer’s capacity to satisfy its obligations.
Interest Rate Risk
Interest rate risk refers to the possibility that bond prices will fall when interest rates rise. When interest rates rise, freshly issued bonds have higher yields, making older bonds with lower yields less appealing to investors.
Inflation Risk
Inflation risk occurs when the rate of inflation exceeds the bond’s yield, lowering the buying power of the interest income. General obligation bond with extended maturities are especially vulnerable to inflation risk since their fixed interest payments may become less attractive over time.
Call Risk
Some general obligation bonds include call provisions, which allow the issuer to repay the bonds before their maturity date.
This usually happens when interest rates have declined, and the issuer may renew the debt at a reduced rate. Call risk can cause investors to receive their investment returned earlier than expected, possibly at an inconvenient moment.
Liquidity Risk
Liquidity risk refers to the possibility that an investor will be unable to sell their general obligation bond quickly or at an acceptable price.
While the municipal bond market is widely regarded as liquid, particular bonds or market situations can make it more difficult to find a buyer at a reasonable price.
General Obligation Bonds FAQs
What are General Obligation Bond?
GO Bonds are a type of municipal bond that is secured by the issuer’s complete faith, credit, and taxing power. They are used to fund public initiatives including infrastructure, schools, and community improvements.
How do General Obligation Bond differ from Revenue Bond?
GO Bonds are backed by the issuer’s general tax authority.
Revenue Bonds are backed by specific revenue streams generated by the project being funded.
What are the risks of investing in General Obligation Bonds?
Credit risk, interest rate risk, inflation risk, call risk, and liquidity risk are the various risks associated with General Obligation Bond investments. Before investing investor must analyse these risks.
Who can invest in General Obligation Bonds?
Individual investors, institutional investors, and anybody seeking a relatively secure fixed-income investment.