What Is an Authority Bond?
An authority bond is a debt security issued by an authority such as a government agency or a corporation formed to manage a public enterprise. Sometimes referred to as a local authority bond, its purpose is to finance the operations of a revenue-generating public business.
Investors buy into authority bonds for a stated period, which allows the financed project to be completed and begin earning revenue, upon which the bond will pay interest at a specified rate. Buyers of authority bonds have a claim to the business's revenues, which serve as the bond's yield. Authority bonds are generally considered low-risk investments, although the risk varies by the issuer, besides general bond risks, namely interest rate risk, inflation risk, and liquidity risk.
- Authority bonds are debt securities issued by corporate or government agencies, or another authority, that are used to finance a public business that will generate revenue.
- Investors buy into the bond for a certain period of time while the project is being completed and begins to earn revenue. Following that period, the bond pays interest at an agreed-upon rate.
- Like a municipal bond, an authority bond correlates to one specific project and is generally seen as low-risk.
- However, authority bonds can be riskier than municipal bonds when they are associated with a project that is less popular than expected and fails to earn the revenue that had been projected.
Understanding Authority Bonds
Authority bonds are issued by an authority such as a government agency, public organization or company The bond's security is from the proceeds of the project it finances. While general bonds finance governmental and civic agencies and infrastructure, an authority bond (like a municipal bond) applies to one specific project.
The risk of an authority bond correlates with the risk of the specific project it finances. While municipal bonds tend to finance low-risk infrastructure projects the community is forced to use as a matter of course, authority bonds may fund projects that have varying degrees of appeal and may not earn the projected revenue.
Authority Bond vs. Municipal Bond
Authority bonds are similar to municipal bonds and are issued by related entities for the same purposes. There is some overlap in the types of projects they back, but there are fundamental differences as well. Municipal bonds tend to be issued for infrastructure projects, while authority bonds are for community organizations or expansions of organizations.
For example, a municipal bond issued for building a new bridge pays bondholders using the tolls from the new bridge. An authority bond, issued for a new wing on a community recreation center, pays bondholders with membership fees or day-pass fees.
Another critical difference is authority bonds incorporate margin protections. Margin protections mean bondholders have a guarantee they haven't overpaid for the bonds. This warranty reduces bondholders' risk because the lower price means the project does not have to earn as much revenue to pay back the bondholders.