General Obligation Bond

A General Obligation Bond is a type of bond which is supported or guaranteed by agencies like municipalities wherein repayments are prompt and have very low default rates as municipals are authorized by the government to increase the tax amount which is receivable from the public to pay off the dues and debts associated with the repayments to the investors.

It is a safe option for any investor, but the returns are comparatively low. In this repayment process, the investors will get the principal and the interest repaid on time. In the case of defaults, the government authorizes the municipalities to increase the tax amount, which is receivable from the public, to pay off the dues and debts associated with the repayments to the investors.

• A general obligation bond is a type of bond guaranteed by entities like municipalities. These bonds offer timely repayments and low default rates due to municipalities having the authority to raise taxes from the public to cover debt repayments to investors.
• Two types of general obligation bonds are limited tax and unlimited tax bonds. These classifications reflect how municipalities can raise taxes to fulfill their repayment obligations.
• Investors considering bond investments should thoroughly research the market and credit rating agencies to make informed decisions. Information about bonds and their specifics is usually accessible through municipal offices.

A General Obligation Bond is a government-aided bond issued to the public to raise capital in case of shortage. The significant investments made for public welfare are sometimes arranged by issuing a general obligation bond.

These types of bonds are popular in the US and were introduced to finance public projects in the country, for example, bridges, roads, repair and maintenance of big public projects, etc. In this, the municipality will be able to handle the difficulties because the municipality makes the call for more taxes during any fiscal shortage. However, the revenues of the municipalities are very well maintained, and the chances of default are rare in general obligation municipal bonds. Many mutual funds and fund transfer exchanges facilitate this scheme's process to make it more accessible for investors.

A general obligation municipal bond is a scheme that is introduced by the municipality to complete certain public projects which require a huge amount of capital. For the upliftment of society, the government sanctions some projects, and at times the municipalities are short of the capital to start and finish the project on time. The municipalities then issue these bonds in the name of that project, and the investors of the project buy the bonds from the municipalities and provide them the capital to start and finish the project. The municipalities guarantee these bonds.

The repayment on these bonds is also very prompt and with interest. There are rare situations when the municipalities default and the investor's repayment is delayed or denied. The projects may fail, but the repayments of the investors are generally cleared. There are situations when the revenues fall short, and the municipalities have asked for taxes to compensate for the same. Thus the process and the repayment of these types of bonds are very prompt, and the investors are at the lowest risk while investing their money in these bonds, and also, the credit rating agencies rank this bond as strong.

There are two types – limited tax and the unlimited tax

1. Limited Tax: In this, the municipality can raise the property taxes to a certain level, and approval from taxpayers is not necessary.
2. Unlimited Tax: Here, the taxpayer's approval is required. There is also no limit to increasing the property tax to clear the municipality's debt.

There are two ways by which an investor can purchase the general obligation bond. First, the investors must take some pain to research the market and the credit rating agencies before investing their money in any bonds. It is available in the municipality offices, and also the bonds can be purchased from brokers. The brokers sell the bonds in the secondary market and charge some commission.

Let us try to understand the concept with the help of an general obligation bond example.

We assume that there is a city name ABC which needs funding for some infrastructural development involving building bridges, dams, renovation of school building, etc. The city has been destroyed due to sudden natural calamity and needs to be rebuilt urgently.

The local municipality decides to issue General Obligation Bonds for the above purpose. Thus, the government evaluates the capital requirements, the cost, benefit and the ability and level of authority to generate tax revenue from the area. A detailed proposal is prepared and approved by the governing body. The financial advisors and the underwriters assist in the issuance process after proper credit rating about the future prospects of the infrastructure in the area.

The bonds are issued through proper process and documentation, and money is collected from banks, insurance companies and mutual funds, through public offering and private placements which the municipality uses to finance the infrastructure projects.

The above general obligation bond example gives a clear explanation of the process of the financial instrument.

Every financial instrument has its own advantages and disadvantages. Let us point out the advantages of this instrument as elaborated below.

• This Bond is considered very safe and a good investment option for investors.
• It is tax-exempt; therefore, it encourages investors to invest money in these types of bonds.
• In case of any default, the investors will get the entire repayments from the tax authority since the municipalities have the right to call for more taxes than usual to pay the dues.
• These bonds are issued in the market, and the capital is being raised on a large scale; thus, it encourages the investors to invest in general obligation bonds.
• This also helps the municipalities to complete the project by issuing bonds in the market.
• In the worst condition or any fiscal deficiency, when the project fails that time, the municipality must clear the debts from the entire revenue.

Some important limitations associated with this financial instrument is given below:

• They provide fewer returns than any other bond present in the market.
• In this, the investors must choose between the returns or risks associated with the bonds.
• It becomes very important for the investors to research the bonds before investing since many general obligation bonds are not tax-free, and the tax authority may not pay the dues.
• Repaying such a bond can be very difficult, although it doesn’t depend upon the operating revenues of the ongoing projects.
• The general obligation bond interest rates are typically low because the government backs it. However, the rates depend on many factors, like the stability of the government, the market conditions, the bond terms and demand, etc. 

It is important to evaluate the benefits and limitations of the issuer before deciding to invest in such bonds. The investor should assess the credit worthiness of the issuer and the type of projects that the proceeds will be invested in.

Both the above are two types of bonds issued by the local and the state governments, with some distinct differences. Let us try to find the differences between them.

• In the case of a General Obligation Bond, the repayment of principal and interest is made from all the revenues, including the taxes at the time of default, whereas in revenue bonds, the repayments are generally made from the operating revenues only.
• The repayment is guaranteed in a general obligation bond because it is made from the general funds of the governemnt. In contrast, in the case of Revenue bonds, the repayment is dependent on operating revenue, or revenue generated form a particular project or any business associate with the bond and thus it is sometimes risky to get the repayments on time.

• The foremer is considered safe and secured because it is backed by government agencies that have the authority to increase the tax and raise money to pay off the debt, whereas the latter is unsecured because the issuer do not have any authority to raise revenue with the permission of the government. They depend on revenue form operations.
• The revenue bonds have no voter approval system since they are backed by projects or enterprises, but the general obligation bonds require voter approval for issuance through ballot initiative or referendum.
• Both use the proceeds raised in different ways. The former uses the money raised to finance public infrastructure projects like schools, bridges, and highways for public benefit. In contrast, the latter uses the proceeds from the bond to finance the infrastructure of the revenue-generating projects.
• The general obligation bonds interest rates will be lower as compared to revenue bonds because the former has government support and is considered safer than the latter.

Thus, both the bonds differ from the point of view of repayment arrangement, security backing, voter approval to raise money and the type of use the raised fund is put into. However, the investors should carefully evaluate the risk and creditworthiness and risk of the issuer before investing in any such types of bond.

This has been a guide to what is a General Obligation Bond. We explain its differences with revenue bonds with example, types, how to purchase & benefits. You may refer to the following articles to learn more about finance –

• Exempt Income
• Guaranteed Bonds
• Green Bonds Definition
• Serial Bond