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Revenue Bonds Definition and Types

08 Feb 2024

Introduction

Bonds issued by local governments and municipal corporations are known as municipal bonds. The funds raised through these bonds help finance public works projects like highways, schools, bridges, hospitals, etc. Municipal bonds are fixed-income investment options that can offer a reliable source of income and tax benefits. 

The two primary categories of municipal bonds are General Obligation (GO) bonds and revenue bonds. GO bonds are supported by the general revenue of the issuing authority. On the other hand, revenue bonds are backed by revenue from the project financed through the bond issuance. In this article, we will explore revenue bonds, their features, types and benefits. 

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What are revenue bonds?

Revenue bonds are municipal bonds issued to finance specific projects such as airports, bridges, highways, hospitals, etc. The repayment of the debt obligation is backed by the revenue generated through fees, tolls, or other charges for using the project. In other words, the principal and interest in revenue bonds are repaid as the project generates income over time. 

The interest rate in revenue bonds is usually higher than in GO bonds, making them attractive investment options. However, these bonds are riskier since their repayment is based on the income generated from a particular project. Unlike GO bonds, there is a possibility of non-payment if the project does not work out as expected. 

Features of revenue bonds

Here are some features of revenue bonds:

  • Long maturity period 

Since revenue bonds are issued to finance long-term projects, they have a longer maturity period. Usually, the maturity period for these bonds ranges between 20-30 years. Both interest and principal are repaid from the operating revenues of the project. So, the payment may be deferred to a later date if sufficient revenues are not generated.

  • Higher returns

Revenue bonds offer higher returns than GO bonds since they involve a higher risk of non-repayment if the project does not work out. 

  • No claim on assets 

You do not have the right to claim the project’s assets if it does not generate the expected revenue. 

  • Call provision 

Revenue bonds are issued with a call provision. This allows the issuing entity to call back the bond if the project is destroyed in a catastrophic event. 

Types of revenue bonds

Now that you know what revenue bonds are and how they work, here are their types:

Type of revenue bond 

Definition 
Public purpose bond  Issued to finance projects for public good such as government buildings or road 
Toll revenue bond  Revenue bond that repays the interest and principal in proportion to toll revenue generated
Airport revenue bond  Issued to fund the construction, redevelopment or expansion of a local airport 
Utility revenue bond  Issued to raise funds for public utility infrastructure such as electricity, water or waste management 
Hospital revenue bond  Issued to finance construction or expansion of hospitals 
Industrial revenue bond  Issued on behalf of a private entity for building or acquiring factories or heavy equipment 
Mortgage revenue bond (housing bond) Issued to fund mortgages for qualifying first-time homebuyers or low-income taxpayers 

Benefits of investing in revenue bonds 

Here are some benefits of investing in revenue bonds:

  • Higher returns than GO bonds 
  • Interest income is usually exempt from taxes 
  • Predictable income with less volatility 
  • Sense of satisfaction by supporting public projects 

Wrapping up 

Revenue bonds are a crucial financial tool that helps governments finance public projects. They work like loans where you can buy the bonds and become a creditor. In return, you receive interest and the principal amount for your investment. Municipal bonds also offer tax benefits. The interest you earn from these bonds is usually exempt from most taxes. Investing in these bonds may seem appealing if you fall under a higher income tax bracket. The non-repayment risk is also negligible. However, these municipal bonds are backed by revenue from a specific project, not by the issuer’s general revenue, making them riskier than GO bonds. Hence, they are a suitable investment choice if you have a high-risk tolerance

 

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