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Revenue bonds make up the vast majority of municipal bonds. They are available in a variety of issues, with each issue varying by what it finances. Investors who want to buy revenue bonds need to know the varieties on the market, as well as how the projects they fund will produce income.
What Are Revenue Bonds?
Revenue bonds are municipal bonds that are secured by specific income of the issuer. The method of securing the loan is what distinguishes them from their municipal cousins, the general obligation bonds (or GO bonds). GO bonds are secured by the full faith and credit of the municipality that issues them.
States, cities, and municipal subdivisions issue municipal bonds. Their purpose is to fund municipal projects, such as housing, hospitals, lighting systems, parking ramps, stadiums, factories, sewer systems, and dozens of other community enterprises. Revenue bonds are municipal bonds that finance income-producing projects. The income generated by these projects pays revenue bondholders their interest and principal. Projects funded by revenue bonds serve only those in the community who pay for their services. GO bonds, in contrast, finance projects that do not produce income but provide services for the entire community.
Most revenue bonds are sold in $5,000 units and mature in 20 to 30 years. However, not all the bonds in the issue mature at the same time; they may have staggered maturity dates. Bond issues with staggered maturity dates are known as serial bonds.
Income from a municipal enterprise is put into a revenue fund. From this fund, expenses for operations are paid first. Only after operations expenses are paid do revenue bondholders receive their payments.
Because they are not backed by the full faith and credit of a municipality as are general obligation bonds, they carry a somewhat higher default risk for which they offer higher interest rates.
Revenue Bond Security
Unlike unsecured general obligation bonds, revenue bonds are secured by specific collateral--the income produced by the projects they fund. The revenues (fees, tolls, concessions, rent, etc.) produced by the projects are used to pay investors. Revenue bonds are not paid by taxes as general obligation bonds are.
Some municipal projects receive additional funding from endowments. The interest from these endowments is sometimes used as revenue bond collateral. Revenue bonds offer higher interest than do general obligation bonds. This is due to the fact that the income from the projects they fund cannot be predicted with certainty. This adds to the perception of lower safety. If the projects do not produce enough revenue, the bonds may default. In that case, the issuer will defer payments to bondholders.
Investors who are willing to risk the possibility of default may choose revenue bonds over general obligation bonds. Some investors protect themselves from default by insuring their revenue bonds.
Ratings firms rate revenue bond issuers for their ability to pay back interest and principal. Bond analysts study the issuers' ability to produce income sufficient to make payments to investors. They also evaluate the cash flow of the income sources, since the success of the bonds ultimately depends on the projects' ability to produce revenue.
Types of Revenue Bonds
The types of municipal revenue bonds are as numerous as the kinds of projects they are used to fund. As you can see, most of them are named for the projects that they finance. Here are the major types:
Revenue Bonds Finance Revenue-Paying Projects
Revenue bonds are municipal bonds that are collateralized by revenue produced by the projects they fund. Because they are not backed by the full faith and credit of a municipality, the way general obligation bonds are, they carry a somewhat higher default risk, but pay higher yields in return. To evaluate a revenue bond, it is important to understand the type and cash flow of the project that will be providing the revenue.
For more information on municipal bonds in general, and about their tax advantages, consult Investing Classroom's other bond courses.
|1||Revenue bondholders receive their interest and principal payments from…|
|2||In order to assess a project's ability to repay bondholders, which part of the project do bond analysts study?|
|3||What are revenue bonds that include backing by a municipality's credit called?|
|a.||Special tax bonds|
|b.||General obligation bonds|
|4||Factories are likely to be financed by which of the following type of revenue bond?|
|5||Which of the following does NOT secure a revenue bond?|
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