Mastering Municipal Securities: Deciphering GO and Revenue Bonds

Municipal securities are debt instruments issued by states, municipalities, or counties to finance public projects. In Chapter 6, Part II, of Understanding Products and Their Risks, we delve into the essential aspects of municipal bonds, explaining their types, funding sources, and special considerations. This guide aims to prepare you for the FINRA Securities Industry Essentials® (SIE®) Exam by offering clear explanations, illustrative examples, and interactive quizzes.

General Obligation (GO) Bonds

What are General Obligation Bonds?

General Obligation bonds are municipal bonds supported by the full faith and credit of the issuing municipality. Unlike revenue bonds, which rely on specific revenue streams, GO bonds are backed by the taxing power of the issuer. They are often used to fund projects that serve the public interest, such as schools, roads, and parks.

Key Characteristics:

• Tax Backing: GO bonds are secured by the issuer’s ability to levy taxes.
• Creditworthiness: A municipality’s financial condition impacts the bond’s credit rating.
• Voter Approval: Issuance often requires voter approval.

Example: Building a New School

A city decides to build a new school and issues GO bonds to fund the construction. The repayment comes from property taxes collected within the city. Because these bonds use tax revenue, they often require public approval via vote.

    graph TB
	    A[Tax Revenue] --> B[General Fund]
	    B --> C[Repayment of GO Bonds]
	    C --> D[School Construction]

Summary Points:

• GO bonds utilize tax revenues for repayment.
• They typically provide more stable security for investors.
• Issuance may depend on public support.

Revenue Bonds

Exploring Revenue Bonds

Revenue bonds finance specific projects and are repaid using the income generated by those projects. Unlike GO bonds, they don’t rely on tax revenue but on user fees, tolls, or lease payments.

Key Characteristics:

• Project-Specific Repayment: Tied to the success of a revenue-generating project.
• Higher Risk: Potential for higher yields due to repayment uncertainty.
• No Tax Requirement: Doesn’t necessitate voter approval or tax levies.

Example: Building a Toll Bridge

Suppose a county builds a toll bridge using revenue bond financing. The tolls collected from vehicles crossing the bridge repay the bondholders.

    graph TB
	    A[Toll Collections] --> B[Revenue Fund]
	    B --> C[Repayment of Revenue Bonds]
	    C --> D[Toll Bridge Project]

Summary Points:

• Revenue bonds hinge on the success of specific projects.
• They offer potentially higher yields compensating for increased risk.
• Provide a funding solution without impacting tax rates.

Special Types of Municipal Bonds and Short-Term Obligations

Municipal securities encompass diverse bond types catering to specialized funding needs or shorter timelines.

Special Types of Bonds:

1. Industrial Development Bonds (IDBs): Issued on behalf of private sector enterprises and repayable through leases or loan payments.
2. Private Activity Bonds: Used for private entities and subject to Alternative Minimum Tax (AMT).

Short-Term Obligations:

• Tax Anticipation Notes (TANs): Interim financing secured against future tax revenues.
• Bond Anticipation Notes (BANs): Short-term borrowing repaid by future bond proceeds.

Summary Points:

• Specialized bonds cater to niche funding.
• Short-term obligations stabilize finances pending revenue intake.
• They provide flexible financial solutions.

Glossary

Glossary of Terms:

• General Obligation Bonds (GO Bonds): Municipal bonds backed by the issuer’s credit and taxing power.
• Revenue Bonds: Bonds repaid through income generated by specific projects.
• Industrial Development Bonds (IDBs): Bonds issued for private enterprise projects.
• Tax Anticipation Notes (TANs): Short-term notes repaid with anticipated tax revenues.
• Alternative Minimum Tax (AMT): A parallel tax system ensuring individuals pay at least a minimum tax amount.

Additional Resources

• Books:

  • “The Bond Book” by Annette Thau
  • “Bonds: An Introduction to the Core Concepts” by Mark Mobius

• Online Resources:

  • FINRA’s Official Site
  • Securities and Exchange Commission (SEC) Municipal Bond Information

• Websites:

  • Investopedia: Municipal Bond Basics

Interactive Quiz

Test your understanding with the following quizzes designed based on the finsra preparation: