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Difficulty: MediumGovernment, Municipal, and Corporate Bonds

A municipality plans to issue debt to finance infrastructure improvements. The city council is evaluating whether to issue General Obligation (GO) bonds or Revenue bonds. Which of the following statements correctly distinguishes a General Obligation bond from a Revenue bond?

  1. General Obligation bonds are backed by the full faith, credit, and taxing power of the municipality and typically require voter approval, whereas Revenue bonds are backed by earnings generated from a specific facility or project.Answer
  2. B
    Interest income from General Obligation bonds is exempt from state and local income taxes for all investors regardless of state residency, whereas Revenue bond interest is fully taxable at all levels.
  3. C
    General Obligation bonds carry significant market interest rate risk, whereas Revenue bonds are immune to price fluctuations caused by rising market interest rates.
  4. D
    General Obligation bonds are sold exclusively to retail investors in the primary market, whereas Revenue bonds trade only between institutional investors in the secondary market.

Answer

General Obligation bonds are backed by the full faith, credit, and taxing power of the municipality and typically require voter approval, whereas Revenue bonds are backed by earnings generated from a specific facility or project.
The defining characteristic of General Obligation (GO) bonds is that they are backed by the full faith, credit, and general taxing power of the issuing municipal entity, which typically requires voter approval and adherence to debt limits. Conversely, Revenue bonds are backed by user fees or project revenues collected from specific facilities, without relying on general municipal taxes.

Step-by-Step Solution

1
Analyze the backing mechanism of General Obligation (GO) bonds.
GO bonds are secured by the full faith, credit, and ad valorem taxing power of the municipal issuer.
Because taxpayers fund GO debt service, statutory debt limitations and voter approval requirements apply.
2
Analyze the backing mechanism of Revenue bonds.
Revenue bonds are secured strictly by revenues derived from operating a specific enterprise or project (e.g., airports, water utilities, toll roads).
Debt service depends on project operational income, so a feasibility study is typically conducted rather than obtaining voter approval.
3
Evaluate the distractors for common candidate misconceptions.
Out-of-state municipal interest is taxable at the state level, and all fixed-income debt faces market interest rate risk.
Tax exemptions and interest rate risks apply consistently across fixed-income instruments based on residency and market rate movements.

Key Concept

Distinction between Municipal General Obligation Bonds and Revenue Bonds
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Topics

Government, Municipal, and Corporate Bonds

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