Browse FINRA Securities Industry Essentials® (SIE®) Exam

Mastering Municipal Securities: Deciphering GO and Revenue Bonds

Dive into municipal securities, discovering General Obligation (GO) bonds, revenue bonds, and more to understand their risks and benefits in finance.

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


Interactive Quiz

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

### General Obligation Bonds are typically secured by: - [x] The taxing power of the issuing municipality - [ ] Revenue from specific projects - [ ] Federal grants - [ ] Private investors > **Explanation:** General Obligation bonds rely on the issuer's taxation authority for repayment, which differentiates them from revenue bonds. ### Revenue bonds differ from GO bonds primarily because: - [x] They are repaid from project-specific revenue - [ ] They are backed by taxing power - [x] They often offer higher yields - [ ] They require voter approval > **Explanation:** Revenue bonds are tied to the income generated by specific projects, unlike GO bonds, and they may provide higher yields due to associated risks. ### A city issuing a bond to fund a school renovation is likely using: - [x] General Obligation bonds - [ ] Revenue bonds - [ ] Industrial Development Bonds - [ ] Private Activity Bonds > **Explanation:** Projects like school renovations serve the general public and typically use GO bonds, leveraging the municipality's taxing power. ### Bonds backed by user fees or tolls are known as: - [x] Revenue bonds - [ ] General Obligation bonds - [ ] Tax Anticipation Notes - [ ] Bond Anticipation Notes > **Explanation:** These bonds fund revenue-generating projects, such as toll roads or bridges, and are repaid by user fees. ### Which bond type might expose an investor to AMT liabilities? - [x] Private Activity Bonds - [ ] General Obligation Bonds - [x] Revenue Bonds - [ ] Tax Anticipation Notes > **Explanation:** Private Activity Bonds (a subtype of revenue bonds) may be subject to AMT, impacting an investor's tax situation. ### A short-term note repaid with future tax revenues is called: - [x] Tax Anticipation Notes (TANs) - [ ] Bond Anticipation Notes (BANs) - [ ] Revenue Bonds - [ ] General Obligation Bonds > **Explanation:** TANs are interim debt securities using anticipated tax proceeds for repayment. ### Characteristics specific to Industrial Development Bonds include: - [x] Issued on behalf of private businesses - [ ] Backed by tax revenues - [x] Repaid through lease payments - [ ] Not subject to AMT > **Explanation:** Industrial Development Bonds facilitate private sector growth, repaid via leases, and may bear specific tax implications. ### Bond Anticipation Notes typically: - [x] Provide short-term funding before long-term bond issues - [ ] Are repaid with tax revenues - [ ] Support private projects - [ ] Involve high-risk investment > **Explanation:** BANs are temporary securities, designed as stopgaps until long-term bond funding is available. ### User fees repaying a municipal bond indicate: - [x] The bond used is a revenue bond - [ ] It ensures risk-free return - [ ] Represents a tax-funded bond - [ ] Demands public voter approval > **Explanation:** Revenue bonds capitalize on user fees for project repayment, emphasizing their self-financing nature. ### True or False: General Obligation bonds require a specific revenue stream for repayment. - [x] False - [ ] True > **Explanation:** GO bonds rely on the issuer's broad tax revenue, not specific income streams like those of revenue bonds.
Tuesday, October 1, 2024