Government bond

Government bond

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A government bond is a bond
Bond (finance)
In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest to use and/or to repay the principal at a later date, termed maturity...

 issued by a national government denominated in the country's own currency
Currency
In economics, currency refers to a generally accepted medium of exchange. These are usually the coins and banknotes of a particular government, which comprise the physical aspects of a nation's money supply...

. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.

History


The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France. It was in the form of a tontine
Tontine
A tontine is an investment scheme for raising capital, devised in the 17th century and relatively widespread in the 18th and 19th. It combines features of a group annuity and a lottery. Each subscriber pays an agreed sum into the fund, and thereafter receives an annuity. As members die, their...

. Later, governments in Europe started issuing perpetual bond
Perpetual Bond
Perpetual Bond is a Big Finish Productions audiobook based on the long-running British science fiction television series Doctor Who.The Companion Chronicles "talking books" are each narrated by one of the Doctor's companions and feature a second, guest-star voice along with music and sound...

s (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 duration
Bond duration
In finance, the duration of a financial asset that consists of fixed cash flows, for example a bond, is the weighted average of the times until those fixed cash flows are received....

.

Credit risk


Government bonds are usually referred to as risk-free bond
Risk-free bond
A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. The rate of return would be the risk-free interest rate. In practice, government bonds are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic...

s, because the government can raise taxes or create additional currency in order to redeem the bond at maturity
Maturity (finance)
In finance, maturity or maturity date refers to the final payment date of a loan or other financial instrument, at which point the principal is due to be paid....

. Some counter examples do exist where a government has defaulted
Default (finance)
In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...

 on its domestic currency debt, such as Russia
Russia
Russia or , officially known as both Russia and the Russian Federation , is a country in northern Eurasia. It is a federal semi-presidential republic, comprising 83 federal subjects...

 in 1998 (the "ruble crisis"), though this is very rare (see national bankruptcy). One other example is Greece 2011 whose bonds are considered very unsafe, in part because Greece does not have an own currency any more, and can't issue more money.

Currency and inflation risk


As an example, in the US, Treasury securities are denominated in US dollars. In this instance, the term "risk-free" means free of credit risk
Credit risk
Credit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....

. However, other risks still exist, such as currency risk
Currency risk
Currency risk or exchange rate risk is a form of financial risk that arises from the potential change in the exchange rate of one currency in relation to another...

 for foreign investors (for example non-US investors of US Treasury securities would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation
Inflation
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time.When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects an erosion in the purchasing power of money – a...

 risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation rate is higher than expected. Many governments issue inflation-indexed bond
Inflation-indexed bond
Inflation-indexed bonds are bonds where the principal is indexed to inflation. They are thus designed to cut out the inflation risk of an investment. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780...

s, which protect investors against inflation risk by increasing the interest rate given to the investor as the inflation rate of the economy increases.

United Kingdom


In the UK, government bonds were called "government stock" or "treasury stock" and the older issues are still called "treasury stock". Newer issues are called "gilts". The name "bond" was reserved for fixed-value investments, which were not tradeable on the stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...

. Inflation-indexed bonds are called Index-linked gilts in the UK.

See also

  • Consol
  • Government debt
    Government debt
    Government debt is money owed by a central government. In the US, "government debt" may also refer to the debt of a municipal or local government...

  • War Bonds
  • Municipal bond
    Municipal bond
    A municipal bond is a bond issued by a city or other local government, or their agencies. Potential issuers of municipal bonds includes cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any...

  • List of government bonds
  • Foreign exchange reserves of the People's Republic of China

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