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Assignment 6

Question 1

There are many causes of insolvency, and eventual bankruptcy which can be categorized into structural drivers and political facilitators. The structural drivers include tax-revenue loss, fiscal imbalances, financial shocks and poor management. The political facilitators include ineffective oversight, lack of transparency and fiscal incompetence. The relationship between the structural drivers and political facilitators to Capital Appreciation Bonds is as explained below.

Tax Revenue Loss

Many states have laid down a set of statutory limits on new Go bonds and the charges may make an assessment on each property as a portion of the value assessed. Many local governments require the consent of the public through voting to raise any existing threshold. Due to national trend leading to a major decline in home values and a consistent hard economic times for many local governments, bond issues that raise property taxes are a political stumbling block. Local government avoid this through seeking CAB’s approval hat are carried ad described by their original cost and regularly hidden in a trance with normal municipal bonds, not the final cost which is way higher. However, making optimistic projections is not advised, particularly at a time when property values are starting to be stable. Most local governments have resorted to CABs which allow submission to debt limits, do not increase taxes, fulfil immediate need for money and postpone debt repayment for at least 20 years.

Fiscal Imbalances

Fiscal imbalance cost can be caused by fast increment of the population, reduction of efficiency or the increment of liabilities or responsibilities. Local governments facing fast growth can have a reasonable need for CABs, if they are utilized with caution, as there is a high possibility of increment of their tax base. However, due to longer lifespans and the rising cost of healthcare, the rise of responsibilities become constant.

Financial Shocks

Like other public sector fields, it is not common to define and plan financial shocks though insurance can help in mitigating the risk. The issue with CABs is that only 22.3% of the total maturity of CABs can be insured and also, only 8.3% of the high debt ratio bonds are insured.

Poor Financial Management

Poor financial management is inclusive of lack of financial competence and a short-term outlook by administrators. This has an adverse effect on the ability of the government of maintaining fiscal sustainability. With CABs, the lack of financial sophistication is severe. This has resulted from the increased marketization of local governments’ bonds for the purposes of high-yield investment. State laws commonly prevent investors from being hired to run bond measures though there is wide circumvention of this restriction.

Ineffective State Government Oversight

The conservative CIB legal framework at the state level do not support local government bankruptcy filings. Though states have different standards and enforcements, a there is a relative effective combination of the four factors to ensure the coherence of the short and long-term consequences of CIBs. Unfortunately, most CABs are created to evade these accountability mechanisms hence encouraging imprudent behavior leading to bankruptcy filings. Public records do not note CABs are as capital appreciation bonds as they are perceived to be harmful to long-term financial health.

Lack of Transparency

The members of the public need to have a sensible sense of the financial strength and utility of using bond strategies. If the full implication of the bond issue is known, there would be more concerns before the endorsement of bond issues. If more communication is made to be the public, better decisions regarding the issuance of bonds will be made.

Fiscal Policy Incompetence

CABs are capable of being used wisely though financial measures such as debt ratios averages and hey have been shown to encourage fiscal policy incompetence. In most cases, using CABs which leads to the pushing of the debt out to the other generations may be seen to be an unethical way of confronting current problems. It is hard to understand the failure to raise property tax for the purpose of reaching needed funds goals and the choice of shifting huge tax increase and financial liabilities to the future generation.

Question 2

There are two major options of financing the school project which are CIBs, which require immediate payments and recognition of maturity values, or CABs, which defer payments and recognition of compounded interest. A capital appreciation bond (CAB) is a municipal security on which the investment return on an initial principal amount is compounded at a stated rate until maturity, at which time the investor receives a single payment representing the face value of the bond and all accrued and compounded interest. CABs can provide short-term funding for local governments who are experiencing growth and know that the tax base will increase and be able to handle incurred costs.

Factors that need to be considered before the decision on which type of financing should be pursued include the ability of the organization to meet near-term obligations. This will include things such as the repayment of principle and the type of interest (compounded interest at maturity or interest quarterly or semi-quarterly over a certain period of years). The cost ratio, the term of repayment and property tax restriction on debt level are also some of the factors to be considered.

The city has, however, been stated to lack the credit rating required to pursue a current interest bond. The option of CAB financing, is therefore, appropriate presently. The community should, however, be informed about the consequences of CAB financing. The benefits of using CAB will include immediate funding, deferred payment and low interest rates in subsequent years. The disadvantages that the community should be informed about include deferred payments, increment of debt costs and unrealistic AV projections. The community will be given the option to accept the terms of CAB use of to wait till the city acquires the credit rating required to pursue CIB.