Question

The University of Kentucky Builds with Bonds

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

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

Additional “guarantees” for bond purchasers are the ratingsgiven the bonds by professional rating agencies. Their bonds arerated “AA-“ by Standard & Poor’s Corporation, which is wellabove investment grade. Thee is always a very good market for thebonds.

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

One advantage for investors: the bonds’ interest revenue idexempt from federal income tax and from state tax for in-stateinvestors. So, an issue offering 6% is the equivalent of 10% tothose individuals in the top tax bracket. Many investors feel veryconfident in buying the bonds, because it is inconceivable to themthat there would ever e a default.

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