Below is the listing of a bond issued by Moorhead, Minnesota. · Explain what it

Question

Below is the listing of a bond issued by Moorhead, Minnesota.  

·      Explain what it means to be a municipal bond.

·      This is a general obligation bond. Explain the difference between a general obligation bond and a revenue bond.

·      The Bond Rating for this bond is AA. What does a bond rating of AA by Fitch mean for the investor and for the City of Moorhead?

·      This bond has a call feature – Explain what it means to have a call feature.

Rating               Issuer – CUSIP                           St         Coupon             Maturity                        Callable

AA Fitch           MOORHEAD MINN                MN      4.000%          02/01/34          Yes   

                        GENEAL OBLIGATION

                        IMPT REF BONDS

Call Prices         Price               Yield to Maturity        Current Yield               First Coupon Date

105.00                       107.36                         3.470%                           3.726%                         02/01/2015

NOTES – Non-Taxable – Bond, Municipal

Explanation / Answer

A bond is a “debt security” issued by an entity. It pays a certain rate of return to its investors, which is called “coupon rate”. A “Municipal bond” is a bond, which is issued by a state, municipality or county to finance its capital expenditure. These bonds are exempt from federal taxes and from most state and local taxes, especially when investor resides in the same state which issued the bond.

General Obligation Bonds:
General obligation bonds are securities guaranteed by the “full faith and credit” of a government with taxing power. These bonds typically are used to finance capital improvement projects such as streets, roads and public buildings. With these bonds, the state or local government bond issuer pledges to use its general taxing power to repay the bondholders. Because these bonds place a general obligation on all taxpayers to cover bond repayments, the voters of a state or local government typically must approve general obligation bonds before they are issued.

Tax Distinction of general obligation bonds:
General obligation bonds can be an unlimited tax type backed by all the taxes the government collects, or they can be limited tax types backed by one specific tax, such as a property tax, or by a specific class of tax, such as excise taxes. General obligation bonds may be subject to a debt ceiling in the government’s constitution, charter or statutes that puts a limit on the amount of general obligation bonds the government can issue.

Revenue Bonds:
Revenue bonds are repaid from the revenues generated by the project the bonds financed. These bonds finance revenue-producing projects such as industrial parks, toll roads, convention centers, sports stadiums or water and sewer utilities. Projects may generate revenues through things like user fees, admission charges, rents or lease payments, or concession fees. In most instances, revenues from the project go into a revenue fund from which operating expenses and bond repayments are drawn.

Bond Guarantees:
Revenue bonds typically come with a variety of “protective covenants” that serve as guarantees to protect the bondholders. There may be covenants that guarantee that rates or fees are high enough to cover costs and debt service or a pledge to keep the facility open and operating for the life of the bonds. Covenants may also include a promise to have the facility completed and operational by a specific date or a pledge to maintain an insurance policy against bond default. Revenue bonds are not subject to debt ceilings.

A bond rating is a grade given to bonds that indicates their credit quality. Private independent rating services provide these evaluations of a bond issuer's financial strength, or its the ability to pay a bond's principal and interest in a timely fashion. Bond ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'C' ("junk"), which is the lowest grade. Different rating services use the same letter grades, but use various combinations of upper- and lower-case letters to differentiate themselves.

'AA' ratings from Fitch denote expectations of very low default risk. They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. This is the second highest rating given by Fitch to any bond. “AAA” is the highest rating given by Fitch.

Call Feature:
A call feature is a feature in a bond agreement that allows the issuer to buy back bonds at a set price within certain future time frames. The issuer uses a call feature to hedge against interest rate risk; bonds can be bought back and replaced by bonds carrying a lower interest rate if interest rates decline. This feature may limit the amount of money that a bondholder might otherwise be able to earn by holding a bond, so investors demand a higher effective interest rate when a call feature is present.

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