Debt Analysis

What are the different forms of public debt?

There are a variety of forms of public debt. These different forms of debt are used to finance projects and to make improvements in the public and private sector. There are differences in the forms of debt such as return on investment and maturation dates and some differences include the source of payment which also determines the level of security. Despite these differences, these forms of debt are vital to the completion of projects and the improvement of programs both in the private and public sector. The following forms of public debt are used for funding a variety of projects.

General Obligation Bonds

One of the most common forms of funding comes from municipal bonds. The general obligation bond is different from other municipal bonds in that it is issued on the grounds of credit worthiness and it is financially secured by taxes. While there is no collateral for these bonds, they are considered relatively safe and pay moderate to low interest rates (O’Sullivan et al, 2003).

Revenue Bonds

Another common form of funding: the revenue bond is a municipal bond which is backed by the revenue derived from a particular project. This type of bond is used to finance any project that is expected to generate revenue i.e., stadiums, civic centers, and other public service projects. The advantage to using revenue bonds as a source of income is that they do not affect public budgets. For example, a revenue bond which is issued for the building of a new stadium will pay the bond debt from profits derived from the stadium which does not affect public operating budgets because the funds are not derived from taxes of services. Although revenue bonds carry a higher risk level than general obligation bonds they are still considered relatively safe and have moderate returns on investment (O’Sullivan et al, 2003).

Certificates of Obligation

Unlike bonds, a certificate of obligation is a written promise to pay a debt. The certificate of obligation is very safe because it is not only backed by the entities credit worthiness but it also pays the debt through taxes and or revenues from services. Essentially the certificate of obligation is a loan used by a public entity (O’Sullivan et al, 2003).

Contractual Obligations

Agreements made between a public entity and a person or company. This form of debt is conditional upon providing a service or good in exchange for monies paid. For example, a construction company which is contracted to build a stadium has an agreement with the state. This contractual obligation means that the state must pay the contractor for the construction service. This form of public debt is common with companies that work for public entities (O’Sullivan et al, 2003).

Commercial Paper

This form of public debt is generally short-term in nature. Public entities will issue commercial paper to raise money for short-term projects or for cash flow needs. Commercial paper is an unsecured debt instrument typically maturing in less than a year. These forms of debt are relatively safe and usually pay at current interest rates (O’Sullivan et al, 2003).

Capital Leases

This form of debt is a lease which transfer ownership from lessor to the lessee at the end of the lease. This form of debt increases the asset value of the lessee and the lessee must also incur the depreciation and risk. The capital lease is not handled the same way as an expense because only the interest rate can be written off in taxes. This form of debt is only considered a capital lease when certain criteria are met;

1. The life of the lease is 75% or greater of the assets useful life.
2. The lease contains a purchase agreement for less than market value.
3. The lessee gains ownership at the end of the lease period.
4. The present value of lease payments is greater than 90% of the asset’s market value (Investopedia, 2012).

Notes Payable

Notes payable are debts that are payable to banks and credit services that are formal agreements. These agreements mandate specific interest rates and terms of repayment. Typically, notes payable are between borrowers both institutional and consumer (O’Sullivan et al, 2003).

The different forms debts are designed to fulfill the needs of borrowers. These lending instruments are important because they allow both public and private borrowers to use funds to expand and to successfully implement programs. With debt instruments of this nature the economy and business in general would slow because it would not be possible to make capital purchases. For these reasons, debt and borrowing is a necessary part of economic structures both public and private.

References

Investopedia. (2012). definition of ‘capital lease’. Retrieved from http://www.investopedia.com/terms/c/capitallease.asp

O’Sullivan, Arthur; Sheffrin, Steven M. (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. pp. 197, 507

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