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Government bond definition

Government bond definition

Government bonds are issued by administrations when they need to borrow money for big infrastructure projects, everyday spending, or to pay down other debts.

They are often sold at auctions, and the investors who buy them become creditors. Each bond comes with a coupon rate (the level of interest that is paid every year,) and a maturity date (when the money initially borrowed is paid back in full.) Generally, they have a face value of $1,000.

Bonds can often have maturity dates that last anywhere from 10 to 30 years. Owners can sell them at any time on a secondary market – however, there are factors that mean they may get less (or more) than the bond’s face value.

How secondary markets for bonds work

One of the biggest risks associated with government bonds is interest.

Let’s imagine that a bond issued in 2000, with a maturity date in 2030, has a coupon rate of 5%. If bonds issued in 2025 only offer a coupon rate of 2%, this would mean that the older bond delivers better annual payouts. Because of this, buyers on secondary markets would end up paying more for the 2000 bond than its $1,000 face value. Conversely, if the 2025 bond boasted a coupon rate of 10%, this would erode the older bond’s face value because it pays substantially less interest.

Bonds: Pros and cons

Government bonds are a low-risk investment because repayments are guaranteed by the country that issues them. However, this varies from country to country, as some nations may have a track record of being able to repay debts in full and on time. When compared with other investments, bonds also offer lower returns.

Alongside interest, another drawback to government bonds is the risk of inflation, where spending power decreases. Generally, the amount of goods and services that can be purchased with $1,000 decreases over the decades, meaning it won’t go as far when the initial sum borrowed is paid back.

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