General obligation (G.O.) and revenue bonds are generally long-term debt securities. When a municipality needs short-term funding, it typically issues notes. These securities usually mature in three months to three years. We’ll cover:
A municipality can issue anticipation notes when it needs to use money before it actually receives it. The basic idea is the same across all types:
Now let’s look at the specific types of anticipation notes.
Tax anticipation notes (TANs) let a municipality fund a project now and repay the borrowing with future tax collections.
For example, suppose a city wants to renovate a local public park but doesn’t currently have enough cash on hand. If the city expects tax collections in a few months, it can issue a TAN. The city borrows the money, completes the renovations, and then uses the tax collections to repay the note.
This is sometimes described as smoothing out cash flow, because it allows the municipality to use expected tax receipts throughout the year rather than waiting for them to arrive.
Revenue anticipation notes (RANs) work the same way as TANs, but repayment comes from future revenues (rather than taxes) generated by a municipal project or facility.
For example, suppose a city owns a zoo and wants to expand it. The city can issue a RAN to fund the expansion, then repay the note using future revenue collections from the zoo. This also helps smooth out cash flow.
Tax and revenue anticipation notes (TRANs) combine features of TANs and RANs. If a municipality wants to fund multiple projects but prefers to issue only one form of short-term debt, it can issue TRANs and repay them using both future tax collections and future revenue collections.
Bond anticipation notes (BANs) are issued in anticipation of a future long-term bond offering.
For example, suppose a city plans to build a new high school and intends to finance it by issuing a G.O. bond. Before the bond is sold, the city might issue a BAN to cover early costs such as architect blueprints and land surveys. When the long-term bond is issued later, the municipality uses part of the bond proceeds to pay off the BAN.
Grant anticipation notes (GANs) are issued when a municipality expects to receive (or has been awarded) a federal grant.
Federal grants are commonly awarded to municipalities and are essentially free money. For example, suppose a state is awarded a grant to expand and improve its public transportation system. Before the grant funds are received, the municipality can issue a GAN to cover up-front costs, such as research and planning for how to use the grant money most efficiently.
Grants are often provided for projects the federal government views as beneficial (for example, environmentally friendly projects).
Variable rate demand notes (VRDNs), also called variable rate demand obligations (VRDOs), are a form of municipal debt that combines:
Because the interest rate resets to the current market rate, VRDNs pay varying interest over time (unlike fixed-coupon bonds).
Although VRDNs are typically issued with long-term maturities, the put option gives investors a way to treat them like short-term holdings. If an investor wants to keep collecting interest for a long period, they can continue holding the note. If the investor wants to exit, they can exercise the put option and redeem the security at par. In that sense, VRDNs can feel both long- and short-term, even though they are technically long-term debt that can be redeemed in the short term.
Investors commonly use the put option if they aren’t satisfied with the new interest rate after a reset. Remember: a bond put option allows the investor to sell the bond back to the issuer at its par value. In practice, the investor controls when the investment ends.
VRDNs (and other securities with variable coupons) generally don’t experience large market price swings when interest rates change. If rates rise, investors expect the coupon to adjust upward on the next reset date. And because the investor can typically put the note back to the issuer at par, the market price usually stays close to par.
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