Definition
Revenue bonds are a type of municipal bond in which the debt service is payable exclusively from the revenue generated by a specified revenue-generating entity associated with the purpose of the bonds, and not from taxes. These bonds are typically issued for projects that will generate consistent cash flows. The proceeds from these bonds can be used to finance infrastructure projects like toll roads, bridges, airports, water, and sewage treatment facilities.
Key Takeaways
- Revenue Bonds are a type of municipal bond that is issued to finance a revenue-generating project and for which the repayment relies solely on the revenue generated from such a project, and not from taxes.
- Revenue bonds come with higher risks than general obligation bonds because they rely on the revenue of the specific project for repayment. This risk, however, also often results in them having higher yields.
- Common projects funded by revenue bonds include highways, airports, and local health care or utilities infrastructures. These projects create student loans, housing loans or industrial developments with the aim of becoming revenue-generating and therefore self-sustainable over time.
Importance
Revenue bonds are essential in the finance world as they allow public and private entities to raise funds for various projects without directly impacting taxpayers.
These bonds are distinct in that their repayment wholly relies on the revenue generated from the project they were issued to fund, rather than taxes or any sort of general funds from the issuing entity.
For investors, revenue bonds can be an attractive investment opportunity due to their tax-free interest income and their potential to fund ventures that can bolster societal infrastructure and development.
Thus, they play a vital role in stimulating financial growth and backing projects that might otherwise be financially unfeasible.
Explanation
Revenue bonds are essential financial instruments primarily used by government bodies, municipalities, or corporations to fund income-generating projects, which might include infrastructure development such as toll roads, bridges, airports, or utilities. The primary purpose of issuing such bonds is to generate necessary capital for projects that have a significant impact on public service or utility but may not have immediate funds available. When a public body issues these bonds, they essentially borrow money from investors who purchase the bonds, using the future projected income of the project to pay off the debt.
Revenue bonds serve as an advantageous method for funding large-scale projects that can generate consistent revenue, such as toll roads or utilities, where the cash flow can be reasonably calculated. The revenue generated from these initiatives pays the interest and principal amount to bondholders. Therefore, the risk associated with revenue bonds is largely related to the performance of the project itself.
If the project fails to generate the expected income, the bond issuer may have difficulty repaying the bondholders. However, as these bonds typically fund public service projects, they often receive strong support and backing, contributing to the local economy’s growth and wellbeing. In turn, this makes revenue bonds an attractive investment to potential bondholders who wish to contribute to their local community while also receiving a potential return on their investment.
Examples of Revenue Bonds
Airport Revenue Bonds: Many airports are funded using revenue bonds. For instance, if a city wanted to build a new airport terminal, they could issue revenue bonds to finance the project. The bondholders would then be repaid through the revenues generated from airport fees, such as landing fees, terminal rents, and other airport charges.
Toll Bridge Revenue Bonds: Toll facilities such as bridges, tunnels, or highways, can also be funded using revenue bonds. For instance, a governing body could issue revenue bonds to finance the construction of a new toll bridge. The bonds would then be repaid from the tolls collected from the individuals who use the bridge.
University Revenue Bonds: Universities often use revenue bonds for their expansion and development projects. For example, the University of California issued revenue bonds to finance their expansion of student housing. The money to repay those bonds comes from the rent collected from students living in these housing facilities.
FAQs about Revenue Bonds
What are Revenue Bonds?
Revenue Bonds are municipal bonds that finance income-producing projects and are secured by a specified revenue source. Typically, Revenue Bonds can be issued by any government agency or fund that is managed for the purposes of business-like activities.
How do Revenue Bonds work?
The issuing body of a Revenue Bond uses the revenues generated by the funded projects to repay bondholders. The payment obligations aren’t backed by the creditworthiness of the issuer but by the revenues the projects are expected to generate.
What are the risks associated with Revenue Bonds?
While Revenue Bonds can offer higher yields compared to general obligation bonds, they come with increased risk. This is primarily because they rely on the revenue of the project or initiative they fund, which can fluctuate or fail. Therefore, there’s a risk that the issuer may not be able to make interest payments or repay the principal at maturity.
What’s the difference between Revenue Bonds and General Obligation Bonds?
Both are types of municipal bonds, but they differ in their source of repayment. General Obligation Bonds are backed by the taxing power of the issuing municipality, while Revenue Bonds are repaid from the income generated by specific projects.
Why should investors consider Revenue Bonds?
Revenue Bonds can offer several benefits to their holders. They often provide a steady income stream and, under certain conditions, this income can be exempt from federal, state, or local taxes. Plus, they can help to diversify an investment portfolio.
Related Entrepreneurship Terms
- Principal Amount
- Issuer
- Interest Payments
- Debt Service
- Maturity Date
Sources for More Information
- Investopedia: A comprehensive source for knowledge related to finance and investing. For specific information on revenue bonds, navigate the website or use the search feature.
- The Balance: This website offers expertly crafted financial information and advice. To find detailed articles about revenue bonds, use the search box on the site.
- MunicipalBonds.com: As the name suggests, this website provides information specifically about municipal bonds, including revenue bonds.
- Fidelity: A well-known financial institution that provides information on a wide range of financial topics, including revenue bonds. You can find relevant information in the ‘Learning Center’ or by using the search feature.
