A government bond is a debt security issued by a national government, usually in the country’s domestic currency, to raise funds for government spending. In return for the money invested, the government promises to repay the face value of the bond on the maturity date, plus periodic interest payments.
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U.S. government bonds are referred to as Treasuries because they are sold by the Treasury Department. Treasuries are backed by the full faith of the U.S. government and are free of state and local taxes on the interest paid. U.S. government bonds are one of most popular financial products because the U.S. government is considered the safest borrower in the world. As a result, the interest rates on U.S. government bonds are very low.
Federal government bonds in the United States include Treasury notes, Treasury bills, Treasury bonds, and Treasury inflation-protected securities. These vary based on “maturities,” or lengths of time until maturity, and amount of interest paid. Treasury Bills are generally considered the least risky, and are sold every week through auctions for maturity periods ranging from one month to one year. Bonds issued by the British government are called gilts. The name is derived from the original Bank of England certificates, which had gilded edges
Government Bonds are considered the safest among the different kinds of bonds and securities because of the general stability and reliability of national economies. Such bonds are often seen as free of credit risk because the government can raise taxes or simply print more money in order to redeem the bond at maturity. But this does not mean government bonds are completely risk-free. There is still inflation risk, meaning the principal repaid at maturity could have less purchasing power, due to higher than expected inflation. There is also a currency risk for foreign investors as the value of the money received when the bond matures will depend on the value of the foreign currency on the maturity date.
Government bonds are ideal for investors with a very low risk appetite. Though the rate of interest paid by such bonds is less when compared to corporate bonds, there is little capital risk as government bonds are issued by large, stable, national entities. However, before deciding to invest in government bonds, investors need to assess several risks associated with the issuing country such as political risk, interest rate risk and inflation risk. There have been instances where a sovereign government has defaulted on its domestic currency debt, such as Russia in 1998 during the “ruble crisis”, though such cases are very few and far between.Want to learn how to generate more income from your portfolio so you can live better? Get our free guide to income investing here.