A general obligation (GO) bond is a type of municipal bond in which the bond repayments (interest and principal) are guaranteed by the total revenue generated by the relevant government entity or agency. In other words, the repayment is guaranteed by both tax revenue and operating revenue generated by various projects. GO bonds are primarily used to subsidize the development of public projects.
GO bonds are different from another type of municipal bonds called revenue bonds. The repayment of revenue bonds is secured only by operational revenue streams generated by the project and cannot be guaranteed by tax revenues. However, as stated above, GO bonds allow using both revenue sources.
Types of General Obligation Bonds
There are two types of general obligation bonds: the limited-tax GO bond and the unlimited-tax GO bond.
1. Limited-tax general obligation bond
A limited-tax GO bond allows municipalities to raise property taxes (within a certain specified limit) when it is necessary to meet the service payments of the debt.
2. Unlimited-tax general obligation bond
An unlimited-tax general obligation bond comes with similar features as the limited-tax version, but with no limit on the property tax increase. The property tax can be increased by up to 100%, but only with the consent of taxpayers. Note that for limited-tax GO bonds, the taxpayers’ approval is not usually required.
How Does a General Obligation Bond Work?
Imagine a situation when a municipality decides to launch a new project, but it lacks sufficient capital to finance the initiative. In such a case, the municipality can issue general obligation bonds.
Investors who purchase the bonds provide capital to the municipality. In return, the investors are entitled to a portion of the municipality’s revenues generated from the project, as well as tax revenues. The revenue streams allow the municipality to honor both the interest and principal payments of the bonds.
Since the repayment is secured by the municipality’s total revenues, there is a low probability of default. Thus, GO bonds are considered safe investments. It is common that such bonds receive strong ratings from credit rating agencies.
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