Revenue bonds 

Revenue bonds 

Bonds come in a variety of sizes and forms. The two primary types of municipal bonds are revenue bonds and general obligation bonds, which you may be familiar with if you’ve ever considered buying them. Revenue bonds are debt obligations issued by municipal organisations and repaid with cash from income-generating projects, including toll bridges, highways, wastewater infrastructure, airport buildings, roadways, and local stadiums. Government organisations frequently issue these, and the money they cost is backed by the money they make from the projects.  

What is a revenue bond? 

A revenue bond is a unique municipal bond that differs from other types of bonds. It guarantees repayment entirely from revenues from a specific company linked to the bonds’ purpose. In contrast to general obligation bonds, only the payments stipulated in the legal agreement between the bondholder and the bond issuer must be used for bond repayment of the principal and interest. 

 

Understanding revenue bonds 

One of the two main categories of municipal bonds is revenue bonds, albeit not all revenue bonds are made equal. Different projects, some of which may have radically different profitability prospects, are financed through each bond sale.  

 Although there is little chance of non-payment, remember that revenue bonds are backed by the success of a particular project, not by a municipality’s general revenue. Investing in revenue bonds may make sense if you want a steady income and can handle some price changes.  

 Additionally, revenue bonds come with tax advantages that high-tax payers may use to their advantage. Governmental organisations primarily fund infrastructure projects with money from revenue bonds. Construction of bridges, highways, airports, sewer infrastructure, and other similar projects isare only a few of the most prevalent instances of these initiatives. 

Characteristics of revenue bonds 

The following characteristics apply to revenue bonds: 

  • As long-term projects are funded with these bonds, the maturity period varies from 20 to 30 years. As a result, these bonds are appropriate for investors with longer investment horizons. 
  • The assets of the sponsored projects do not belong to the bondholders, which means that bondholders do not have the right to take possession of the project’s assets if the tasks cannot bring in enough money to achieve the promised returns. 
  • These bonds typically have a callable nature, which allows the issuer to call them back in the event of a dire circumstance. 
  • Since there is a danger of default on these bonds if projects fail, the issuing bodies frequently offer insurance or a federal bond guarantee. 
  • Principal and interest payments are made when the relevant projects’ operating costs have been covered. However, fees may be postponed to a later date if operating income is insufficient to cover expenses, which increases the risk of non-payment or default. As a result, these bonds provide higher returns than conventional municipal bonds to make up for the chance to investors.

Structure of revenue bonds 

Revenue bonds can be issued in various denominations, including US$1,000 US$ and US$5,000 US$, and typically mature in 20 to 30 years. The sum paid to the investor or bondholder at the bond’s maturity is referred to as the bond’s face value, which is the bond’s value. Some revenue bonds mature on different dates and at other times. They are referred to as serial bonds.  

An investor can purchase a revenue bond by paying the bond’s face value upfront. The investor will receive interest payments over the bond’s lifespan in exchange. If the project generates enough money to repay the bond at maturity, the investor will receive their face value back. Investors risk losing their entire investment if the project generates more money. 

Example of revenue bonds 

Consider the following example to understand revenue bonds. Dylan makes fixed-income investment decisions. He notes that the regional government intends to earn US$ 5 million by selling revenue bonds to fund the development of the new toll bridge.  

 According to Dylan’s project analysis, the new bridge will cut the distance between the two nearby cities’ travel times in half. He decides to purchase the bonds since he is confident that the toll bridge will produce enough revenue streams. The bonds have a US$1,000 US$ face value, a 30-year maturity, and a 2.5% interest rate. The proceeds from tolls collected once construction is complete will repay the interest and principal. 

 

Frequently Asked Questions

State and local governments frequently issue the following types of revenue bonds: 

  • A municipality or airport authority may issue an airport revenue bond, a municipal bond backed by income from the airport facility.  
  • A kind of municipal security called a toll revenue bond is used to finance the construction of public works, including bridges, tunnels, and motorways.  
  • Municipal debt securities called utility revenue bonds are used to fund public utility projects.  
  • A particular kind of municipal bond known as a hospital revenue bond is used to finance the development of new hospitals, nursing homes, or associated facilities.  

 

One advantage is that interest income from revenue bonds is typically exempt from federal, state, and local taxes. Investors in high-income tax brackets stand to gain quite a bit from it. It is well-liked in states with high tax rates because of this benefit. 

 

Revenue bonds are disadvantaged over general obligation bonds in that they are vulnerable to higher default risks because they are not backed by the municipality’s full faith and credit.  

These bonds are also long-term, implying that the money invested is blocked for a very long period. They provide comparatively lower interest rates than corporate bonds with a similar investment horizon. 

 

An investor can purchase a revenue bond by paying the bond’s face value upfront. The investor will receive interest payments over the bond’s lifespan in exchange. 

 

Governmental organisations primarily use revenue bonds to fund infrastructure projects. The most frequent tasks are building sewer infrastructure, highways, bridges, and airports.

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