A government bond is a debt security issued by a government to finance its operations. It is a promise to pay the holder of the bond a fixed sum of money, usually on a specific date, and to repay the principal amount of the loan plus interest.
What is a government bond? (Definition #2)
A government bond is a debt security issued by a government, typically with a maturity of 10 to 30 years. Government bonds are considered risk-free assets, because the government has the ability to raise taxes or borrow money in order to repay its debts. Interest payments on government bonds are exempt from federal income tax.
Types of government bonds
In the United States, there are six types of government bonds: municipal bonds, treasury bonds, corporate bonds, agency bonds, junk bonds and international bonds.
- Municipal Bonds: Municipalities issue municipal bonds to finance public projects such as schools, hospitals and roads. The interest on municipal bonds is tax-free at the federal level and often at the state level as well.
- Treasury Bonds: are issued by the U.S. government and are considered the safest type of bond because they are backed by the full faith and credit of the U.S. government.
- Corporate Bonds: Corporate bonds are issued by companies to finance a wide variety of projects such as new factories, research and development or acquisitions. The interest on corporate bonds is taxable at both the federal and state levels in most cases.
- Agency Bonds: are a type of debt security issued by government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac. Agency bonds are considered to be safe, high-quality investments, as the GSEs are backed by the full faith and credit of the United States government. Agency bond prices tend to be more stable than those of corporate bonds, and they typically offer a higher yield than Treasury securities.
- Junk Bonds: In the financial world, a junk bond is a high-yield debt security issued by a company with relatively low credit ratings. Junk bonds are so named because they are considered to be more risky than investment-grade securities. In order to compensate investors for the added risk, junk bonds typically offer higher yields than other types of debt. Junk bonds can be a great investment for certain people in certain situations. Note: However, they should not be taken lightly; because of their high risk, they can be quite volatile and may not be appropriate for all investors. Before buying any junk bonds, it is important to do your research and understand the risks involved.
- International Bonds: bonds are also a way to invest money internationally. When looking for bonds to invest in, there are a few things you should consider. One is the credit rating of the issuer. The higher the rating, the less likely it is that the issuer will default on its debt. Another consideration is how long the bond will mature. The longer the maturity, the higher the yield you can expect to receive. However, there is more risk associated with longer-term bonds since they are more likely to lose value if interest rates rise during that time period.
Issuing government bonds
Governments all over the world issue government bonds to finance their operations. A government bond is a debt security issued by a government to raise money. The government sells the bond to investors, and agrees to repay the bond’s face value at a set date in the future. In return, the investors receive a fixed rate of interest on their investment.
- The amount of money that a government can borrow depends on its credit rating. The higher the credit rating, the more money the government can borrow.
- The interest rate on a government bond varies depending on market conditions. The credit rating is determined by ratings agencies such as Standard & Poor’s and Moody’s. These agencies assess a country’s ability to repay its debt, based on factors such as economic stability and levels of debt and deficits.
Uses of government bonds
These bonds are typically used to finance large projects or to cover budget deficits.
How to buy government bonds
Bonds can be held in a variety of different ways, including in individual or joint accounts, through a broker or agent, or in a fund. They can also be traded on the secondary market like any other security.
#1 Buying Government Bonds through an ETF
A very common and safe way to buy a government bond is through an Exchange Traded Fund (ETF) because of its advantages: they are easy to sell, they allow you to choose which bonds to pick (active management) and the fees are lower than traditional mutual funds (see #2).
Many companies offer their ETFs to buy bonds. The best known is undoubtedly BlackRock through its iShares fund. You can invest in bonds with terms from 1 to 3 years (iShares 1-3 Year Treasury Bond ETF); from 3 to 7 years (iShares 3-7 Year Treasury Bond ETF); from 10 to 20 years (iShares 10-20 Year Treasury Bond ETF), and so on.
Generally, the longer the investment period of the bond, the higher the interest they pay. There are many ETF for investing in Government Bonds, this link is just an example: BlackRock’s iShares for U.S. Government Bond ETF.
#2 Investing in Government Bonds through a Mutual Fund
Unlike the previous case, a mutual fund allows you to invest in government bonds but with certain disadvantages: higher commission, you cannot choose which bonds to buy since we are talking about a passive investment management.
#3 Direct Investment in Government Bonds
It is possible to invest directly in Government Bonds if your broker allows it. If you do not have a broker, we recommend you read: Checklist: How to Choose a Stock and Bond Broker.
> See list of traditional brokers and exchanges.
Advantages of investing in government bonds
Government bonds offer investors a number of benefits, including:
- A fixed interest rate that does not change over the life of the bond.
- Predictable payments that are backed by the full faith and credit of the government.
- Tax breaks on the interest payments.
Disadvantages of investing in government bonds
One investment option that often seems like a safe bet is government bonds. However, there are several disadvantages to investing in government bonds that investors should be aware of.
- Lower yields than other types of investments. This means that investors will earn less money on their investment over time.
- Very sensitive to interest rate movements; if interest rates go up, the value of the bond goes down, and vice versa.
- Difficulty to sell them. Another downside to investing in government bonds is that they can be difficult to sell if need be. This is because there is usually a limited market for them, and they can often take longer to sell than other types of investments.
In conclusion, a government bond is a type of security that is issued by a government in order to borrow money. These bonds are typically used to finance large projects or to cover budget deficits. Government bonds are considered low risk investments, and they offer investors a fixed rate of return over a predetermined period of time.