Government bond


A government bond or sovereign bond is a bond issued by a national government, generally with a promise to pay periodic interest payments called coupon payments and to repay the face value on the maturity date. The aim of a government bond is to support government spending. Government bonds are usually denominated in the country's own currency, in which case the government cannot be forced to default, although it may choose to do so. If a government is close to default on its debt the media often refer to this as a sovereign debt crisis.
The terms on which a government can sell bonds depend on how creditworthy the market considers it to be. International credit rating agencies will provide ratings for the bonds, but market participants will make up their own minds about this.
For example, a bondholder invests $20,000 into a 10-year government bond with a 10% annual coupon; the government would pay the bondholder 10% of the $20,000 each year. At the maturity date the government would give back the original $20,000.

History

The Dutch Republic became the first state to finance its debt through bonds when it assumed bonds issued by the city of Amsterdam in 1517. The average interest rate at that time fluctuated around 20%.
The first official government bond issued by a national government was issued by the Bank of England in 1694 to raise money to fund a war against France. The form of these bonds was both lottery and annuity. The Bank of England and government bonds were introduced in England by William III of England, who financed England's war efforts by copying the approach of issuing bonds and raising government debt from the Seven Dutch Provinces, where he ruled as a Stadtholder.
Later, governments in Europe started following the trend and issuing perpetual bonds to fund wars and other government spending. The use of perpetual bonds ceased in the 20th century, and currently governments issue bonds of limited term to maturity.
During the American Revolution, the U.S. government started to issue bonds in order to raise money, these bonds were called loan certificates. The total amount generated by bonds was $27 million and helped finance the war.

Risks

Credit risk

A government bond in a country's own currency is strictly speaking a risk-free bond, because the government can if necessary create additional currency in order to redeem the bond at maturity. There have however been instances where a government has chosen to default on its domestic currency debt rather than create additional currency, such as Russia in 1998 .
Investors may use rating agencies to assess credit risk. The Securities and Exchange Commission has designated ten rating agencies as nationally recognized statistical rating organizations.

Currency risk

Currency risk is the risk that the value of the currency a bond pays out will decline compared to the holder's reference currency. For example, a German investor would consider United States bonds to have more currency risk than German bonds ; similarly, a United States investor would consider German bonds to have more currency risk than United States bonds. A bond paying in a currency that does not have a history of keeping its value may not be a good deal even if a high interest rate is offered.
The currency risk is determined by the fluctuation of exchange rates.

Inflation risk

Inflation risk is the risk that the value of the currency a bond pays out will decline over time. Investors expect some amount of inflation, so the risk is that the inflation rate will be higher than expected. Many governments issue inflation-indexed bonds, which protect investors against inflation risk by linking both interest payments and maturity payments to a consumer price index. In the UK these bonds are called Index-linked bonds.

Interest rate risk

Also referred to as market risk, all bonds are subject to interest rate risk.
Interest rate changes can affect the value of a bond. If the interest rates fall, then the bond prices rise and if the interest rates rise, bond prices fall. When interest rates rise, bonds are more attractive because investors can earn higher coupon rate, thereby holding period risk may occur. Interest rate and bond price have negative correlation. Lower fixed-rate bond coupon rates meaning higher interest rate risk and higher fixed-rate bond coupon rates meaning lower interest rate risk.
Maturity of a bond also has an impact on the interest rate risk. Indeed, longer maturity meaning higher interest rate risk and shorter maturity meaning lower interest rate risk.

Money supply

If a central bank purchases a government security, such as a bond or treasury bill, it increases the money supply because a Central Bank injects liquidity into the economy. Doing this lowers the government bond's yield. On the contrary, when a Central Bank is fighting against inflation then a Central Bank decreases the money supply.
These actions of increasing or decreasing the amount of money in the banking system are called monetary policy.

United Kingdom

In the UK, government bonds are called gilts. Older issues have names such as "Treasury Stock" and newer issues are called "Treasury Gilt".Cite web |url=http://www.dmo.gov.uk/reportView.aspx?rptCode=D3B.2&rptName=72460326&reportpage=Gilts/Daily_Prices |title=UK Debt Management OfficeDead link|date=April 2020 |bot=InternetArchiveBot |fix-attempted=yes

U.S. Government Bonds

The U.S.Treasury offered severals types of bonds with various maturities. Certain bonds may pay interest, others not.
These bonds could be:
The principal argument for investors to holding U.S. Government Bonds is that the bonds are exempt from state and local taxes.
The bonds are sold through an auction system by the government. The bonds are buying and selling on the secondary market, the financial market in which financial instruments such as stock, bond, option and futures are traded. The secondary market may be separate into two market categories over-the-counter market and exchange market.
The Treasury Direct is the official website where investors can purchase treasury securities directly from the U.S. government. This online system allow investors to save money on commissions and fees taken with traditional channels. Investors can use banks or brokers to hold a bond.