Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Obligation Bond

What it is:

An obligation bond is a municipal bond that was issued to purchase property or tangible assets.

How it works (Example):

The face value of an obligation bond is usually larger than the value of the property associated with the bond.  For example, let's assume City XYZ wants to build a new stadium. It must purchase a parcel of land for $10,000,000 from a private landowner. The cost to issue $10,000,000 in municipal bonds to pay for the land is $1,000,000.

The city issues an $11,000,000 obligation bond. It borrows an extra $1,000,000 ($11,000,000 - $10,000,000) to compensate the bondholders for the extra costs (the closing costs on the bond issue).

Obligation bonds also generally require the issuer to pledge some of the revenue from the project to the bondholders.

Why it Matters:

An obligation bond is designed to ensure that lenders are able to protect their collateral and receive compensation for the costs associated with issuing the municipal bonds.