Obligation Bond – Definition

Cite this article as:"Obligation Bond – Definition," in The Business Professor, updated July 29, 2019, last accessed October 27, 2020, https://thebusinessprofessor.com/lesson/obligation-bond-definition/.


Obligation Bond Definition

An obligation bond refers to a form of municipal bond that secures a mortgage on property or some other physical asset. The market value of an obligation bonds is more than the worth of its collateral.

A Little More on What is an Obligation Bond

An obligation bond is a particular kind of municipal bond that makes the borrower personally liable for the expenses in addition to the borrowed property’s or asset’s worth. Such expenses including transaction costs and closing costs need to be paid to the lender.

Obligation bonds are a sub-division of municipal bonds or debt securities that a state, municipality, or nation issues for financing capital or long-term expenditures such as development of infrastructure, construction of schools, libraries, roads, etc. Similar to municipal bonds, obligation bonds are free from any federal taxes, and the majority of state and local taxes. And this exemption makes it tempting for the individuals falling in high income-tax brackets. A private entity, public firm borrowing for large-scale projects, or a nonprofit company can issue municipal bonds. The category or class of these bonds is determined on the basis of interest payments and repayments of principal amount. Municipal bonds belong to either categories of obligation bonds or revenue bonds.

A revenue bond works in contrast to an obligation bond. It secures the principal amount and payments of interest by sales, taxes, fuel, etc.

Making Investment in Municipal Bonds

In comparison to corporate bonds, municipal bonds involve lower amount of risk. But revenue bonds are more exposed to changes in economic conditions and consumer tastes and preferences. For instance, a facility offering water, doing a sewage treatment, or proffering premium services will have more dependable income than the rentable shelter facility of a park.

Investors prefer municipal bonds because of the tax relief provided by them. They are an effective alternative for conservative investors who prefer earning fixed income. Besides saving affluent investors from paying additional taxes, municipal bonds can be organized depending on different objectives as per the location, tenure, and credit quality.

Municipal bond is a fixed-income security whose market price varies with fluctuations in interest rates. This means that when interest rates are high, the prices of bonds decrease; when interest rates fall, the prices of bond increase. Also, bonds that mature in the long-run are more likely to vary with the changes in interest rate rather than a bond with a lesser maturity. This results in bigger fluctuations in the income of the person who invested in municipal bonds. As most of the municipal bonds are not liquid in nature, the investor would have to sell other securities in case of urgent cash requirement.

References for “Obligation Bond



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