Securities Industry Essentials (SIE) ExamUnderstanding Products and Their RisksMedium
A client purchases a municipal bond issued by the City of Springfield for $1,000 with a coupon rate of 4% and a maturity of 10 years. The bond is a general obligation bond. Which of the following statements is TRUE regarding the security of this investment?
- AThe bond is secured by the full faith and credit of the issuing municipality, backed by its taxing power.
- BThe bond is subject to federal income tax but exempt from state and local taxes.
- CThe bond's principal and interest payments are guaranteed by the federal government.
- DThe bond is backed by the revenues generated from a specific project.
Show answer & explanationAnswer & explanation
Correct answer: A. The bond is secured by the full faith and credit of the issuing municipality, backed by its taxing power.
General obligation (GO) bonds are backed by the full faith and credit of the issuing municipality, which includes its power to levy and collect taxes. This provides a high degree of security for investors.
Why the other options are wrong
- B. Municipal bonds are typically exempt from federal income tax and often from state and local taxes for residents of the issuing state, not subject to federal tax.
- C. Municipal bonds are generally not guaranteed by the federal government.
- D. This describes a revenue bond, not a general obligation bond.
General Obligation (GO) Bond
A municipal bond backed by the full faith and credit and taxing power of the issuing municipality.
- Secured by the issuer's general tax revenues (e.g., property, sales taxes)
- Requires voter approval for issuance
- Considered very safe due to broad tax backing
- Used to finance public projects that do not generate revenue
Memory trick: GO Bonds: General Obligation, General Taxes, General Security.