Full Faith and Credit

Full Faith and Credit Government Bonds General Obligation Bonds U.S. Government Securities Public Finance Debt Repayment
Full faith and credit refer to the comprehensive commitment of a government entity to use its taxing and borrowing power and other revenue sources to ensure the payment of interest and principal on its issued bonds.
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Full Faith and Credit

Definition

The term “Full Faith and Credit” is a phrase that signifies a government entity’s absolute pledge to utilize all available taxing and borrowing powers, in addition to other revenue streams, to fulfill its commitments of paying interest and repaying the principal on its issued bonds. This assurance primarily backs U.S. government securities and general obligation bonds (GOBs) of states and local governments.

Examples

  1. U.S. Treasury Bonds: These bonds are backed by the full faith and credit of the United States government, assuring investors of the government’s commitment to meet its debt obligations.
  2. Municipal General Obligation Bonds: A city might issue a general obligation bond to fund public projects like schools or infrastructure, backed by the city’s full taxing authority and other revenue.

Frequently Asked Questions (FAQs)

Q1: What does “full faith and credit” guarantee to bondholders?

  • A1: It guarantees that the issuing government entity will use all available financial resources, including its power to tax and borrow, to ensure timely payment of interest and principal.

Q2: How does “full faith and credit” differ from revenue bonds?

  • A2: Full faith and credit bonds are backed by the government’s general revenues and taxing power, while revenue bonds are repaid from specific revenue sources like tolls or utility payments.

Q3: Are U.S. government securities risk-free due to full faith and credit?

  • A3: They are considered very low-risk investments because they are backed by the full financial power of the U.S. government.
  • General Obligation Bonds (GOBs): Bonds issued by local or state governments that are backed by their full taxing power and general revenues.
  • Revenue Bonds: Bonds that are repaid from the revenues generated from the specific projects or sources the bonds are issued to finance.
  • Municipal Bonds: Debt securities issued by states, cities, counties, and other governmental entities to fund public projects.

Online References

  1. Investopedia - Full Faith and Credit
  2. U.S. Securities and Exchange Commission

Suggested Books for Further Studies

  1. “Public Finance and Public Policy” by Jonathan Gruber.
  2. “Investing in Municipal Bonds: How to Balance Risk and Reward for Success in Today’s Bond Market” by Philip Fischer.
  3. “The Basics of Public Budgeting and Financial Management” by Charles E. Menifield.

Fundamentals of Full Faith and Credit: Financial Management Basics Quiz

### What is the definition of "full faith and credit"? - [x] A pledge that uses the full taxing and borrowing power, plus other revenue sources, to ensure payment of interest and principal of bonds. - [ ] A promise to only use tax revenues for debt repayment. - [ ] A commitment to repay bonds only through specific revenue streams. - [ ] A promise limited to state government entities. > **Explanation:** Full faith and credit refer to the comprehensive pledge by a government entity to employ all its financial resources to guarantee bond repayments. ### To which type of bonds does "full faith and credit" primarily apply? - [ ] Corporate bonds - [x] U.S. Treasury bonds and general obligation bonds - [ ] Revenue bonds - [ ] Junk bonds > **Explanation:** The term primarily applies to U.S. Treasury bonds and general obligation bonds issued by state and local governments. ### What distinguishes general obligation bonds from revenue bonds? - [ ] GOBs are repaid from project-specific revenues. - [ ] GOBs are unsecured. - [x] GOBs are backed by the issuer's full taxing power. - [ ] GOBs have higher interest rates than revenue bonds. > **Explanation:** General obligation bonds are backed by the issuing entity's full taxing power, unlike revenue bonds which are repaid from specific project revenues. ### How is investor confidence affected by the "full faith and credit" pledge? - [x] It increases because investors are assured of payment. - [ ] It decreases because of higher risk. - [ ] It has no effect on confidence. - [ ] It depends on the issuer's market reputation. > **Explanation:** The full faith and credit pledge increases investor confidence by ensuring that the government will fulfill its debt obligations. ### Are municipal bonds always backed by full faith and credit? - [ ] Yes, all municipal bonds are. - [ ] No, only infrastructure bonds are backed. - [x] No, only general obligation bonds have this backing. - [ ] Yes, but only at the federal level. > **Explanation:** Not all municipal bonds are backed by full faith and credit; only general obligation bonds have this backing. ### What resources are pledged under full faith and credit? - [ ] Just the income from projects funded by bonds - [x] Full taxing and borrowing power, plus other revenues - [ ] Exclusive lottery revenues - [ ] Federal aid funds > **Explanation:** Full faith and credit pledge the government's full taxing and borrowing power, and other available resources. ### Why are U.S. Treasury bonds considered low-risk? - [x] Because they are backed by the full faith and credit of the U.S. government. - [ ] Because they are issued in large quantities. - [ ] Because they offer high interest rates. - [ ] Because they only exist in digital form. > **Explanation:** U.S. Treasury bonds are considered low-risk as they are comprehensively backed by the full faith and credit of the U.S. government. ### What is the primary difference between a revenue bond and a general obligation bond? - [x] Revenue bonds are repaid from specific revenues; general obligation bonds use full taxing power. - [ ] Revenue bonds are state-issued; general obligation bonds are federal-issued. - [ ] Revenue bonds are always tax-free. - [ ] General obligation bonds are shorter-term securities. > **Explanation:** Revenue bonds are specifically repaid from project revenues, while general obligation bonds are backed by the issuer's overall taxing and financial power. ### How does the full faith and credit pledge affect the interest rates on bonds? - [x] It generally lowers them due to reduced risk. - [ ] It raises them due to high risk. - [ ] It has no impact at all. - [ ] It causes rates to fluctuate. > **Explanation:** Full faith and credit typically lower interest rates since the reduced risk makes the bonds more attractive to investors. ### Who issues bonds with a full faith and credit pledge? - [ ] Only private corporations - [x] Government entities such as the U.S. Treasury and local governments - [ ] Non-profit organizations - [ ] International banks > **Explanation:** Bonds with a full faith and credit pledge are issued by government entities like the U.S. Treasury and state or local governments.

Thank you for exploring the fundamentals of full faith and credit in public finance and tackling our quiz questions! Continue to enhance your knowledge in financial management!

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