Moral Obligation Bond
What Is Moral Obligation Bond?
Moral obligation bond is a tax exempt revenue bond issued by a municipality, or comparative government body, that conveys with it a moral, however not legal, commitment to stay away from defaulting on payments, even it means appropriating funds from somewhere else.
Understanding Moral Obligation Bonds
A moral obligation bond not just gives investors the tax exemption benefits inherent in a municipal bond, yet in addition gives an extra moral pledge of protecting lenders against default. This has credibility as the responsible body's commitment is upheld by a reserve fund laid out to meet any debt service costs the government might not be able to make. Thus, while they isn't the legal obligation to keep away from default, the moral basic holds influence with investors.
A municipal authority might issue debt as bonds to raise capital to finance projects. The two types of municipal bonds are general obligation bonds (GO) and revenue bonds. The interest payment and principal repayment of an overall obligation (GO) bond are funded from the state or nearby government's financial money vaults. These bonds are backed by the full faith and credit of the municipal government which might have the authority to increase taxes to satisfy its payment obligations in a hurry bond. Then again, payment obligations on a revenue bond are backed by the projected revenue stream of the project for which the bond was issued. One form of a revenue bond is the moral obligation bond.
Special Considerations
A moral obligation bond is secured by a non-binding covenant which permits the responsible government to fitting funds (appropriation) to compensate for any shortfall in funds expected to service the debt. This extra security given by the government is just morally - and not legally - binding. Be that as it may, the pledge is generally viewed as being essentially as trustworthy as a legally binding commitment on the grounds that the responsible government would face negative credit rating effects assuming it failed to respect the pledge. Subsequently, the municipal body has great incentive to follow through with its interest obligations to keep away from default.
For instance, a bond is issued to finance the construction of an airport in a major city. The revenue created by the airport is the source of income stated to service the bond and repay the principal when the bond develops. Be that as it may, on the off chance that the revenue created from airport services misses the mark regarding the required amount expected to satisfy the municipality's interest payments, the issuer can't increase taxes on its inhabitants to compensate for this shortfall. With a moral obligation bond, the issuer is committed to put forth a purposeful attempt to look for other financing courses in other to make its interest and principal payments to investors.
Since moral obligation bonds are not secured by the full faith and credit of the issuer, bondholders face the risk of losing every one of their investments assuming the issuer defaults on its payments. Due to the higher risk, these bonds regularly have a higher yield than general obligation bonds to make up for the additional risk. Notwithstanding the higher yield earned, interest income from moral obligation bonds is exempt from federal taxes and most state taxes assuming that the investor lives in the state or municipality giving the debt.
Features
- Since moral obligation bonds are not secured by the full faith and credit of the issuer, bondholders risk losing every one of their investments in the event that the issuer defaults on its payments.
- Moral obligation bond is a tax exempt revenue bond issued by a municipality, or comparable government body, that conveys with it a moral, however not legal, commitment to abstain from defaulting on payments, even it means appropriating funds from somewhere else.
- Moral obligation bonds normally have a higher yield than GO bonds to make up for the additional risk.
