Capital finance and debt
Question 1: Explain the difference between guaranteed and non-guaranteed bonds, and under what circumstances governments would use one or the other. How has the use of each type of bond changed over time?
Guaranteed bonds are financed by the full faith and credit of the issuing government. That is the issuer pledges to reimburse the debt using its resources which include all the assets accessible to the issuer in order to satisfy the debt. In this case, it may require the legal authority to raise taxes if necessary. Non-guaranteed bonds are those that are financed by precisely recognized revenue sources and do not have the lawful backing of a superior governmental unit with taxing power (Lee, 492). The guaranteed bonds are safer investments than the non-guaranteed bonds. Guaranteed interest rate is lower than the non-guaranteed bonds.
Non-guaranteed bonds have become common in special districts like water and sewer authorities and economic development zones. The local governments have also been advised to favor Non-guaranteed over guaranteed bonds due to their limitations. The changes experienced in general bonds will need voters’ approval which has become difficult hence the use of revenue bonds.
Traditionally, municipalities and local utilities issued bonds in the local market and the local or regional banks used to be the main purchasers. Recently, these circumstances have changed and the debt still falling within the two general categories (guaranteed and non-guaranteed) and banks are no longer the largest holders of these debts. Bond issues are now open to be purchased by institutional investors who are distant from the issuing authority.
Question 2: Explain in detail two nontraditional bond-financing methods. What separates these from the general obligation bonds? Under what circumstances are nontraditional bonds desirable?
- Securitizing the future revenue stream which are a set of receivables was an improvement in the private sector and it was presented in the 1980s. It involves a stream of payments that are legal obligations and the credit card holder for controls already made on the mortgages. This is because the mortgage company issues a bond against the future payments that are predetermined because the mortgage holders has already suffered the debt. On the other hand, the securitization may involve an identified value for the revenue stream such as unsettled mortgage debt, plus estimated additional payments for credit card debt not yet earned. Securitization may comprise of different risks than conventional revenue bonds and, therefore, may be priced higher if considered by the market as riskier investments. The revenue stream is also clearly known, that the security may be considered less risky than a partly theoretical future revenue stream. An example is Airport Passenger Facility Charges (498)
- Tax Increment Financing Bonds combine features of revenue bonds and general obligation bonds. They are used to fund local economic development by guaranteeing future increases in property taxes of areas targeted for development or improvement. The improvement will not directly generate revenues, it is not appropriate for revenue bond financing. At the same time, the city may not wish to obligate its full resources to repay the bonds, may be at state debt-limit ceilings for full faith and credit bonds. A tax increment financing bond will back up the debt issue with the pledge of amplified property tax revenue from the area being developed (500).
Question 3: What factors influence government credit ratings?
These factors include interest rate offered and level of risk levels which are derived through a rating of different reports from the issuer. These reports are quantitative and qualitative analyzed to give the final status of the issuer financial position. Some of these reports are:-
- A number of current years of annual audited financial statements
- A number of years of budget history and forecasts for the succeeding years
- Capital development program
- Bases of major revenues if general-purpose authority, and revenue source for the issue if a revenue bond
- Comprehensive statement of all unsettled debt and terms of debt
- Simple economic circumstances in the area of the issuing authority, which include employment rates, major employers, literacy and other education characteristics, property valuation, and sources of regular intergovernmental revenue
- Debt management strategies
- Simple institutional characteristics such as contextual and familiarity of key organizational and elected officials and mechanisms in case of electoral, appointment and the regularity for interchanging key officials; and significant national or state regulations that affect the processes of the issuer.
This information is used by rating agencies as a combination of several types of data are exclusive, but generally are moderately transparent to the issuer by use of lengthy interviews and time onsite by experts from the rating agencies in order to explain the data requirements and the method the data is used in making a rating.
Question 4: Explain the main measures of government debt and debt capacity. Which one constitutes the better measure? Why?
- The main measures of debt capacity are expenditure pressures, resource accessibility, and the commitment of government administrators to use funds to meet debt requirements.
- Expenditure analysts concentrate on the current and prospective future obligations of the authorities. Some of the important effects on potential prospect expenses are Population growth, changing financial circumstances, the current capital amenities and infrastructure base, and the socioeconomic features of the population (523).
- Evaluating resource availability contains analyzing all possible sources of revenue which include own-source revenues; transfers from other levels of government; and types of self-financing, which include user charges, special valuations, impact fees, and a diversity of other measures to collection fees or revenues adequate to support the specific projects (523).
- The readiness of lenders to acquire a debt is reflected by the interest rate they will need to lend. Revenue and expenditure examines are used by state and local governments to support capital planning and debt management. Fiscal capacity examination, focus on the ability to produce revenues and on expenditure necessities, which is used to determine current fiscal circumstances and estimate upcoming conditions (524).
Lee, Robert D, Ronald W. Johnson, and Philip G. Joyce. Public Budgeting Systems. United States of America: Jones & Bartlett Learning, 2013.