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Government bond

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Government bond

A government bond is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date. Government bonds are usually denominated in the country's own currency. Another term similar to government bond is "sovereign bond". Technically any bond issued by a sovereign entity is a sovereign bond but sometimes the term is used to refer to bonds issued in a currency other than the sovereign's currency. If a government or sovereign is close to default on its debt the media often refer to this as a sovereign debt crisis.[1][2][3]

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.

History

The first general government bonds were issued in the Netherlands in 1517. Because the Netherlands did not exist at that time, the bonds issued by the city of Amsterdam are considered their predecessor which later merged into Netherlands government bonds. The average interest rate at that time fluctuated around 20%.

The first ever bond issued by a national government was issued by the Bank of England in 1693 to raise money to fund a war against France. It was in the form of a tontine. The Bank of England and government bonds were introduced in England by William III of England also called William of Orange who copied the 7 Dutch Provinces approach of issuing bonds and raising government debt where he ruled as a Stadtholder to finance England's war efforts.

Later, governments in Europe started issuing perpetual bonds (bonds with no maturity date) 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.

Risks

Credit risk

Government bonds in a country's own currency are sometimes taken as an approximation of the theoretical risk-free bond, because it is assumed that the government can raise taxes or create additional currency in order to redeem the bond at maturity. There have been instances where a government has defaulted on its domestic currency debt, such as Russia in 1998 (the "ruble crisis") (see national bankruptcy).

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 (since the dollar may go down relative to the euro); similarly, a United States investor would consider German bonds to have more currency risk than United States bonds (since the euro may go down relative to the dollar). 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.[4]

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 prices index.

Money supply

If a central bank purchases a government security, such as a bond or treasury bill, it increases the money supply, in effect creating money.

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".[5][6] Inflation-indexed gilts are called Index-linked gilts.[7]

UK gilts have maturities stretching much further into the future than other European government bonds, which has influenced the development of pension and life insurance markets in the respective countries.

See also

External links

  • Global array of government bonds, listed by country and instrument

References

  1. ^ "Sovereign Bond Definition". investopedia.com. 2011. Retrieved 15 December 2011. 
  2. ^ "What is Sovereign Deb". 
  3. ^ "Portugal sovereign debt crisis". 
  4. ^ Analysis: Counting the cost of currency risk in emerging bond markets | Reuters
  5. ^ http://www.dmo.gov.uk/reportView.aspx?rptCode=D3B.2&rptName=72460326&reportpage=Gilts/Daily_Prices
  6. ^ "Gilt Market: About gilts". UK Debt Management Office. Retrieved 2011-06-13. 
  7. ^ "Gilt Market: Index-linked gilts". UK Debt Management Office. Retrieved 2011-06-13. 
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