What Is a Government Bond?

A government bond is a debt security issued by a government to support government spending. Government bonds can pay periodic interest payments called coupon payments. Government bonds are considered low-risk investments since they're backed by the government.

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Government Bond

Government Bonds Explained

Government bonds are issued by governments to raise money to finance projects or day-to-day operations. The U.S. Treasury Department issues bonds via auctions at various times throughout the year. Some Treasury bonds or Treasuries can trade in the secondary market whereby investors can buy and sell previously issued bonds through a financial institution or broker.

Treasuries are considered risk-free since they're backed by the full faith and credit of the U.S. government. Treasuries are typically used by market participants as a benchmark in comparing the risk associated with securities since Treasuries offer the closest thing to a risk-free rate of return. The 10-year Treasury bond is also used as a benchmark and guide for interest rates on lending products.

Key Takeaways 

  • A government bond is a debt security issued by a government to support government spending.
  • Government bonds can pay periodic interest payments called coupon payments.
  • Government bonds are considered low-risk investments since they're backed by the government.
  • There are various types of bonds that are offered by the U.S. Treasury that have various maturities, some pay interest, while some do not.

How Government Bonds are Used

Government bonds assist in funding deficits in the federal budget and are used to raise capital for various projects such as infrastructure spending. However, government bonds are also used by the Federal Reserve Bank to control the nation's money supply.

When the Federal Reserve repurchases U.S. government bonds, the money supply increases throughout the economy as sellers receive funds to spend or invest in the market. Any funds that are deposited into banks are used by financial institutions to lend out to companies and individuals, further boosting economic activity.

Pros and Cons of Government Bonds

Pros

  • Some bonds offer steady interest income while others sell at a discounted price to their face value

  • Considered safe-haven investments in times of economic downturns since there's little risk of default

  • Some government bonds are exempt from state and local taxes

  • Can be bought and sold easily in the market and are available through mutual funds and exchange-traded funds

Cons

  • Offer low rates of return relative to equities and corporate bonds

  • Only select bonds keep up with inflation, which is a measure of price increases throughout the economy

  • Carry interest rate risk when interest rates are rising since investors holding fixed-rate bonds earn lower yields compared to the market

  • All government-backed bonds, particularly those in emerging markets may carry increased risk such as country risk, political risk, central-bank risk, and interest rate risk

Real World Examples of U.S. Government Bonds

There are various types of bonds offered by the U.S. Treasury, which have various maturities, some pay interest, while some do not.

Savings Bonds

The U.S. Treasury offers two types of savings bonds, series EE bonds and series I bonds. The bonds are sold at face value and receive a fixed rate of interest. However, if the bond is held for 20 years, the value of the bond will reach its face value, effectively doubling. Series I bonds receive a second rate tied to an inflation rate calculated on a semi-annual basis.

Treasury Notes

Treasury notes (T-notes) are intermediate-term bonds maturing in two, three, five, or 10 years. They provide semiannual interest payments at fixed coupon rates. T-Notes typically have a $1,000 face value; those with two- or three-year maturities have a $5,000 face value.

Although yields changes daily, the 10-year yield closed at 2.406% on March 31, 2019, and at that time had a 52-week range of 2.341% to 3.263%.

Treasury Bonds

Treasury bonds (T-Bonds) are long-term bonds maturing between 10 to 30 years. T-Bonds provide semi-annual interest payments and have $1,000 face values. The bonds fund shortfalls in the federal budget, regulate the nation’s money supply, and execute U.S. monetary policy. The 30-year Treasury bond yield closed at 2.817% on March 31, 2019.

Treasury Inflation-Protected Securities (TIPS)

Treasury inflation-protected securities (TIPS) refers to a Treasury security that is indexed to inflation to protect investors from the adverse effects of rising prices. The par value or principal increases with inflation and decreases with deflation, as measured by the Consumer Price Index. TIPS pay interest every six months based on a fixed rate determined at the bond's auction. However, the interest payment amounts can vary since the rate is applied to the adjusted principal or value of the bond. TIPS are issued with maturities of five, ten, and thirty years. On March 29, 2019, the 10-year was auctioned with an interest rate of .875%.