General Obligation Bond (GO)

Introduction

When it comes to financing public projects, governments often turn to bonds as a means of raising capital. One type of bond that is commonly used is the General Obligation Bond (GO). In this article, we will explore what a General Obligation Bond is, how it works, and why it is an attractive investment option for both individuals and institutions.

What is a General Obligation Bond?

A General Obligation Bond is a type of municipal bond issued by state and local governments to fund public projects such as schools, roads, and infrastructure improvements. Unlike revenue bonds, which are backed by specific revenue streams such as tolls or fees, General Obligation Bonds are backed by the full faith and credit of the issuing government entity.

Essentially, this means that the government pledges to use its taxing power to repay the bondholders. If the government is unable to generate enough revenue from taxes to make the required payments, it may raise taxes or cut spending in other areas to fulfill its obligation to bondholders.

How do General Obligation Bonds work?

General Obligation Bonds are typically issued with a fixed interest rate and a maturity date. The interest rate is determined based on market conditions at the time of issuance and the creditworthiness of the issuing government. The maturity date is the date on which the bond will be fully repaid.

Investors who purchase General Obligation Bonds receive regular interest payments, usually on a semi-annual basis, until the bond reaches its maturity date. At that point, the investor receives the full face value of the bond.

General Obligation Bonds are often sold through a competitive bidding process, where underwriters submit bids to purchase the bonds at the lowest interest rate. The winning bidder then resells the bonds to investors at a slightly higher interest rate, allowing them to make a profit.

Why are General Obligation Bonds attractive to investors?

There are several reasons why General Obligation Bonds are attractive to investors:

• Low default risk: Since General Obligation Bonds are backed by the full faith and credit of the issuing government, they are considered to have a low risk of default. This makes them a relatively safe investment option compared to other types of bonds.
• Steady income: General Obligation Bonds provide investors with a steady stream of income in the form of regular interest payments. This can be particularly appealing to retirees or other individuals who rely on fixed income investments.
• Tax advantages: The interest income from General Obligation Bonds is often exempt from federal income taxes, and in some cases, state and local taxes as well. This can provide investors with significant tax advantages, especially for those in higher tax brackets.
• Diversification: Including General Obligation Bonds in an investment portfolio can help diversify risk. Since they are backed by the government, they tend to have a low correlation with other asset classes, such as stocks or corporate bonds.

Case Study: General Obligation Bonds in California

One example of the use of General Obligation Bonds is in the state of California. In 2018, California voters approved a $4 billion General Obligation Bond measure to fund affordable housing programs. The bonds were issued with a maturity date of 30 years and an interest rate of 3.5%.

The proceeds from the bond sale were used to provide loans and grants to developers to build affordable housing units. The interest payments on the bonds were funded through a combination of state funds and revenue generated from the affordable housing projects.

This case study illustrates how General Obligation Bonds can be used to finance important public projects that benefit the community as a whole.

Conclusion

General Obligation Bonds are a valuable tool for governments to finance public projects and provide investors with a safe and attractive investment option. With their low default risk, steady income, tax advantages, and diversification benefits, General Obligation Bonds can be a valuable addition to an investment portfolio.

Whether you are an individual investor looking for a stable income stream or an institution seeking to diversify your holdings, General Obligation Bonds offer a compelling investment opportunity. By understanding how General Obligation Bonds work and their benefits, you can make informed investment decisions that align with your financial goals.