Section 4- Part 8-10

Question 1

Long Term Financing Options

Answer 1

Bonds
Notes
Lease Purchases
Certificates of Participation

Question 2

Bonds

Answer 2

A government bond is a legal contract to pay face value of the bond at maturity, a fixed date in the future.17 The issuer also pays interest at a fixed rate. Most bonds pay periodic interest throughout the life of the bond, but some bonds may carry only a single interest payment

Question 3

General Obligation Bonds

Answer 3

Form of government debt that is backed by the full faith and credit of the government. Contrasts with revenue bonds.

Due to the inherent advantage of “full faith and credit” backing, general obligation bonds are often issued at lower interest rates than revenue bonds. However, general obligation bonds are also more likely to be subject to debt limits. Typically, general obligation bonds are used to fund projects that benefit all citizens served by the government

Question 4

Revenue Bonds

Answer 4

Revenue bonds are secured by a specific source of financing, such as revenue from the project being funded or a dedicated tax. Due to the greater risk associated with revenue bonds, they are usually issued at higher interest rates than general obligation bonds

Question 5

Term Bond

Answer 5

A block of bonds in which all bonds in the issue mature on the same date or near the same date, usually many years after issuance. Contrasts with serial bonds.

Question 6

Warrant

Answer 6

A negotiable monetary instrument issued by a state or local government or the federal government.

Question 7

Notes

Answer 7

Form of government debt used as a short-term financing source. Due to the short maturity period, the principle and interest for a note are frequently retired simultaneously upon maturity (that is, no periodic interest payments).

Question 8

Short Term and Long Term Notes

Answer 8

Short-term notes are sometimes issued in anticipation of other revenue and are redeemed when the other revenue becomes available. For example, BANs (bond anticipation notes) are redeemed with proceeds of long-term bonds and RANs (revenue anticipation notes) might be redeemed with property tax proceeds. Given their shorter duration and reduced risk, notes are typically issued at lower interest rates than bonds. For a short-term note, the principal and interest are redeemed simultaneously upon maturity (that is, no periodic interest payments).

Question 9

Lease Purchases

Answer 9

Practice by which a government entity assumes a long-term lease on a capital asset and, at the end of the lease period, the asset may transfer to the government. Usually, these long-term obligations do not require voter approval.

Question 10

Capital Leases

Answer 10

A lease of real property that meets defined criteria requiring the government to report the property as if it were purchased with the proceeds of long-term debt.

Question 11

Certification of Participation (COP)

Answer 11

Form of shared government financing. In a typical form, several financial institutions share in a loan arrangement with a government entity

Question 12

Advantage of COP

Answer 12

A purported advantage of COPs is they enable entities to avoid debt limits and raise (borrow) money for capital projects without approval of the voters. The advantage to participants (investors) is that the income stream is exempt from taxes. The debt is often secured by the capital asset, not general revenue funds.

Question 12

Credit Rating Agencies

Answer 12

Rating Factors
Rating Codes

Question 13

Creating Rating Agencies

Answer 13

Independent organization that assesses the credit worthiness of borrower. Three major rating agencies are Standard & Poors, Moody’s Investor Service and Fitch Ratings.

Question 14

Rating Factors

Answer 14

Several weeks before the proposed issue date, the government presents information to a rating agency. The government is seeking a favorable rating that will result in lower interest rates. Information presented by the government and evaluated by the rating agency includes:

• Covenant or details of the individual issue—purpose of debt, source and flow of funds for repaying the debt, legal limitations on the flow of funds and bondholders rights.
• Debt management issues—debt maturity schedules for the new issue and previous issues; entity’s ability to repay the debt, especially in light of existing and planned obligations.
• Economic base—economic outlook for the jurisdiction, population and employment trends and real estate values.
• Financial performance—trends in overall revenues and expenditures; sources of government revenue.
• Administrative issues—how the entity is organized, powers and responsibilities of officials who will manage the debt repayment.

Question 15

Rating Codes

Answer 15

Rating agencies assign a letter rating to debt issues. The rating indicates the likelihood of default (nonpayment) on principal and interest. Three major rating agencies are Standard & Poor’s, Moody’s Investor Service and Fitch Ratings. The table below is a condensed illustration of two rating scales. (For instance, the Moody’s Aa rating can be further parsed as Aa1, Aa2, or Aa3.)

Question 16

Rating Code- Higher Rating

Answer 16

Governments desire the highest rating possible. Entities with lower ratings must pay higher interest rates to attract investors. And since the investment policies of other governments and institutions may prevent them from purchasing lower rated securities, a low rating limits the number of potential investors.

Question 17

Enhancing the Security of Local Government Debt

Answer 17

Bond Issuance
Debt Guarantees

Question 18

Bond Issuance

Answer 18

Bond insurance increases confidence, among potential investors, that the principal and interest payments will be made. This added assurance is particularly valuable for municipal bonds issued by cities, counties, school districts or other special districts.

Question 19

Note on Bond Issuance

Answer 19

f all other factors are equal, a bond issue that is secured by third-party insurance will be attractive at lower interest rates than a non-insured bond issue. Since the bonds will sell at lower interest rates, the issuer saves borrowing costs, even after paying for the bond insurance.

The bond insurance companies are themselves rated by the credit rating agencies (Moody’s, Fitch, or Standard & Poor’s). When a bond issue is insured, the credit rating that is assigned by the rating agency is based on the rating of the third-party insurer, as well as the underlying credit rating of the government that issues the bonds.

Question 20

Debt Guarantees

Answer 20

Bond insurance increases confidence, among potential investors, that the principal and interest payments will be made. This added assurance is particularly valuable for municipal bonds issued by cities, counties, school districts or other special districts.