WHAT YOU NEED TO KNOW ABOUT GOVERNMENT BONDS

Just like corporate bonds are IOUs by the companies issuing the bonds, government bonds are IOUs to the general public to borrow money that will be returned at a predetermined time at face value with interest payment periodically up to maturity.

Governments issue these bonds when they have more money needs than can be satisfied by tax revenue. Another reason is to regulate the amount of money circulating in the economy. If there is too much money (which can cause inflation), the government issues bonds that it will buy back (redeem) at a given future date and this reduces the money supply. It does the exact opposite when there is too little cash in the economy i.e. redeems the already issued bonds.

They also have other names in other parts of the world. In the UK they are called gilts or gilt edged securities and in the US they are called treasuries. Also bonds issued by governments in foreign countries are referred to as sovereign bonds.

To some extent these government bonds reflect what will happen to interest rates in the future. If interest rates are expected to rise, investors will sell to keep any capital gains and prices will fall. This is because as interest rates rise their prices fall. On the other hand, if the interest rates are expected to fall investors buy for the higher yields that the bonds have as at that time and for the future capital gains, means that their prices rise. It goes without saying that anything that affects interest rates, inflation, economic growth and expectations about both also affects these bonds.

As am sure you have come to learn that more often than not returns in investments like bonds and mutual funds are directly related to risk i.e.  the lower the risk the lower the returns and vice versa, this means that governments bonds are good for the conservative risk averse investor that does not want to risk hard earned money and doesn’t necessarily require high yields. An investor like this would be interested in risk government bonds because of the higher safety in that at maturity, the government can raise taxes to get enough cash to redeem them and thus a lower risk of default.

Other than a steady fixed income in the form of interest paid either annually or semi annually, the low risk of invested capital invested if bonds are held to maturity, a fixed date of maturity, they have a provide a more diversification to a portfolio mostly dedicated to more risky investments(everyone needs safety once in a while)

The best time to but the government bonds is when they are first issued because buying them from the secondary market since expecting to profit from them here has a number of variables like the time to maturity, market interest rates, credit worthiness of the issue (the risk of default) and the liquidity of the bond(some bonds are virtually impossible to sell at certain times). Also if an investor pays less than the face value of the bond(at a discount), he stands to profit when the bond matures to its face value. If he buys at face value or at a premium(above), there is a higher likelihood for a loss when the bond matures.

Another good thing is that you do not have to wait until maturity to sell the bonds. You can sell them in the secondary market and profit if the interest rates have gone down since you bought the bonds and lose if the rates have gone up. There is a lot more on this in a small fascinating government bond post that I have just found. Please read through it because their explanations contain figures and ease understanding.

That is an overview of the government bonds. I will take you deeper into them in future so sit tight.

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