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Analyzing General Obligation Bonds

Instructor: LeRoy Rands

Bill has taught college undergraduate and MBA classes in finance, economics & management, 40 years of finance experience and has a MBA degree.

Municipal bonds are debt instruments issued by public entities like states, cities, and counties to raise capital. The most common type of municipal bonds are general obligation bonds.

General Obligation Bonds

George is a new municipal bond analyst at ABC Financial preparing for his Series 7 exam and he knows one of the topics he needs to study is general obligation bonds and is wondering what he should know.

General obligation bonds (GO) are the most common type of municipal bond offered by states, cities, counties, and other municipal entities. General obligation bonds are issued so that the municipality can raise the capital they need for infrastructure and new construction that they cannot finance through the general revenues of the municipality.

There are other types of municipal bonds including revenue bonds, special assessment bonds, and tax-backed bonds. All of the different types have different features so each must be analyzed a little differently. This lesson discusses the characteristics of general obligation bonds and the factors to investigate to understand the credit worthiness of a general obligation bond offering.

George is wondering what he needs to look at in order to understand the risk of a general obligation bond offering.

Characteristics of General Obligation Bonds

General obligation bonds are issued by a municipality to raise necessary funds either to support its operating needs or to finance a capital project that does not generate an income stream to pay off the bond. For instance, a typical use of a general obligation bond would be to finance a new school, a library, municipal building, or road construction.

The bottom line is the municipality issuing the general obligation bond is relying on property taxes, sales taxes, and fines and fees to pay off the debt. The soundness of the bond is therefore dependent on the issuing entity's current financial situation and it's ability to meet its revenue projections.

George is looking at an upcoming general obligation bond issuance by XYZ County. He is collecting all the information to determine whether he should recommend XYZ County's bonds to ABC's customers.

Marketability

One of the prime things that George has to determine is whether a general obligation bond offering can be easily marketed. Some of the factors that have to be considered are:

  • The credit rating of XYZ County - the higher the credit rating, the more marketability the bonds are.
  • Maturity - the longer the maturity of the bond, the harder it is to sell. Luckily, XYZ's bonds have a 5-year life which makes them easier to sell.
  • The price of the bonds - as with stocks, the lower the price the more interested investors will be.
  • Interest or coupon rate - XYZ is offering a 4% interest rate on its bonds. George thinks this is a little low for XYZ's credit rating.
  • Call option - call options built into a bond offering make the offering less attractive to investors.
  • Sinking fund - when the issuer has to regularly put money into a fund for the retirement of the bonds, it makes the offering more attractive.

Overall, George decided that XYZ's general obligation bond offering would be marketable. It would be more attractive to ABC's customers if the coupon rate was higher, but George felt it would still sell.

Ability to Handle Debt

Another area of concern is a public entity's ability to deal with debt. George has to look into XYZ County's past history as well as its current financing activity. Some of the questions that need to be answered are:

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