Government bonds are debt securities issued by a country’s government in its own currency. A government bond is a debt instrument that helps the government to raise capital when required. The first government bonds were issued by the British government in 1693 when it needed capital to fund its war with France.
High-quality bonds are issued by the governments of Italy, Germany, France, Japan, the UK and the US. The government bonds issued by the US Department of the Treasury are considered to be the safest and are globally accepted.
How Do Government Bonds Work?
Government bonds are valued in increments of 100 and have a maturity period of one year to 30 years. However, these bonds are generally not bought at face value and are acquired either at a premium or at a discount. A bondholder receives a fixed interestrate (also called coupon rate) during the term of the bond. The interest is typically made biannually (half-yearly payments). The entire principal amount (the face value of the bond) is received when the bond reaches its maturity date.
Instead of waiting till the maturity date to recover the principal amount, bondholders can sell their government bonds in the secondary market. Bondholders can realize a profit if the prevailing interest rate falls below the coupon rate after the bond is issued.
Benefits of Government Bonds
The benefits of government bonds include:
- These bonds regulate the nationwide circulation of cash.
- Investments in these bonds are safer than investing in the stock market.
- Negligible credit risk since government typically have the highest credit ratings.
Dangers of Government Bonds
Some of the dangers of government bonds are:
- These bonds are prone to political upheavals, coups and power turmoil in the country. These are the only circumstances when a government can default on interest payments and debt repayment.
- In case an investor purchases a bond issued by the government of a foreign country, the returns can be impaired by fluctuations in the foreign currency market.
- Inflation can significantly lower or wipe off the returns from these bonds.
- Government bonds yield lower returns than corporate bonds or equities.