Question

The University of Kentucky Builds with Bonds

Every year, hundreds of colleges around the country build new buildings. Where do most schools get the money for these expensive projects? From long-term bonds.   

The University of Kentucky (UK) has issued “revenue” bonds to build buildings on the 23,000 student Lexington campus, and on 14 community colleges throughout the state. These bonds pledge the school’s revenues as collateral to guarantee payment of the bonds. At one time the outstanding debt on the Lexington campus buildings was $137 million. The total debt on the community college buildings equaled $121 million. The bonds generally have maturities ranging from 10 to 20 years.

Additional “guarantees” for bond purchasers are the ratings given the bonds by professional rating agencies. Their bonds are rated “AA-“ by Standard & Poor’s Corporation, which is well above investment grade. Thee is always a very good market for the bonds.

People in Kentucky identify very closely with the university. Even though the bonds are rated “AA-” they trade at AAA (the top bond rating) because they are so easy to sell.

One advantage for investors: the bonds’ interest revenue id exempt from federal income tax and from state tax for in-state investors. So, an issue offering 6% is the equivalent of 10% to those individuals in the top tax bracket. Many investors feel very confident in buying the bonds, because it is inconceivable to them that there would ever e a default.

3) Explain the meaning to the tax-exempt status of the University of Kentucky bonds. What does it mean to say that “a recent issue offering 6% is the equivalent of 10% to those individuals in the top tax bracket?”

Answer 1

the bonds offering by University of Kentucky were tax free to the investors. As the bonds are long term investment vehicle in nature, the investors are provided the feature, tax free bonds. In general the income on bonds is taxable income according to income tax laws. But there are some investment tools which provide tax free income due to long term investment or for encouraging investment in certain areas, the governments can announce tax free income.

Hence, bonds from this university are tax free and it may equal to 10% taxable income to the investors.