Question

California issued debt (general obligation bonds) to fund the state budget and must now repay what it borrowed. Given the facts above, please indicate if you think that California’s debt is more likely to be internal or external. How do you know? Furthermore, is the repayment of state and local government debt likely to drain purchasing power from citizens in those areas?

Answer 1

BOND MEANING

Bond is instrument used by the goverment to raise money from fionancial market through public issue.

General Obiligation Bond

A general obligation bond (GO) is a municipal bond backed by the credit and taxing power of the issuing jurisdiction rather than the revenue from a given project. General obligation bonds are issued with the belief that a municipality will be able to repay its debt obligation through taxation or revenue from projects.General obligation bonds also serve as a way for local governments to raise funds for projects that create streams of income for things such as roads, parks, equipment, and bridges. General obligation bonds are usually used to fund government projects that will serve the public community.

The issuer of a municipal bond receives a cash purchase price at the time of issuance in exchange for a promise to repay the purchasing investors, or their transferees, (the bond holder) over time. Repayment periods can be as short as a few months (although this is very rare) to 20, 30, or 40 years, or even longer. The issuer typically uses proceeds from a bond sale to pay for capital projects or for other purposes it cannot or does not desire to pay for immediately with funds on hand. Tax regulations governing municipal bonds generally require all money raised by a bond sale to be spent on capital projects within three to five years of issuance. Certain exceptions permit the issuance of bonds to fund other items, including ongoing operations and maintenance expenses in certain cases, the purchase of single-family and multi-family mortgages, and the funding of student loans, among many other things.

Because of the special status of most municipal bonds granted under Section 103 of the Internal Revenue Code, which provides that the interest on such bonds is exempt from gross income, investors usually accept lower interest payments than on other types of borrowing (assuming comparable risk). This makes the issuance of bonds an attractive source of financing to many municipal entities, as the borrowing rate available to them in the municipal, or public finance, market is frequently lower than what is available through other borrowing channels.

Types of General Obligation Bonds

There are two types of general obligation bonds: the limited-tax GO bond and the unlimited-tax GO bond.

1. Limited-tax general obligation bond

A limited-tax GO bond allows municipalities to raise property taxes (within a certain specified limit) when it is necessary to meet the service payments of the debt.

2. Unlimited-tax general obligation bond

An unlimited-tax general obligation bond comes with similar features as the limited-tax version, but with no limit on the property tax increase. The property tax can be increased by up to 100%, but only with the consent of taxpayers. Note that for limited-tax GO bonds, the taxpayers’ approval is not usually required.

in this case its an internal debt as internal debt, is borrowed from individuals and institutions within the country repayment will constitute only a re-distribution of resources without causing any change in the total resources of the community.There can, thus, be no direct money burden caused by internal debts since all payments cancel each other out in the aggregate community as a whole. Whatever is taxed from one section of the community servicing the debts is distributed among the bond-holders by way of repayment of loans and interest; and quite often, the tax-payer and the bond-holder may be the same person.

External debt is the portion of a country's debt that is borrowed from foreign lenders, including commercial banks, governments, or international financial institutions. These loans, including interest, must usually be paid in the currency in which the loan was made. To earn the needed currency, the borrowing country may sell and export goods to the lending country.