Definition of Government Bonds
Government bonds are the debt obligations of a national government, or another government entity. In the United States, the term generally refers to U.S. government bonds, such as treasury bonds and treasury notes. However, there are other government bonds, including municipal bonds (issued by cities and states) and foreign sovereign debt (the government bonds of other countries).
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U.S. Government Bonds
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U.S. government bonds are one of most popular financial products in the world. The United States government owes over $13 trillion, and this takes the form of government bonds. These bonds tend to operate like most other bonds: a buyer pays a certain amount up front (the "face value") and gets biannual interest payments. When the bond matures, they get their original investment back. This way, the buyer is compensated for the fact that they do not have access to their money.
The U.S. government is considered one of the safest borrowers in the world, so the interest rates on U.S. government bonds are very low. Currently, the government pays interest of 3.5% per year on 10-year bonds.
Municipal Bonds
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Municipal bonds are bonds issued by local--not national--governments. These include states and cities, as well as specific government projects that generate revenue. For example, a town may want to create a new toll road, for which they believe tolls will pay for the cost in a decade. Instead of saving up their money, they could borrow to build the toll road. If the bond they issue has a coupon of 5 percent, and the toll road earns 10 percent of its cost each year, the bond's interest will be paid with money left over.
Some municipalities have had trouble with their debt in recent years. Investors who consider municipal bonds should remember that although they are safer than other forms of debt, it is still possible to lose money. Because of their safety, these bonds have a lower "yield" (the amount of money earned from interest) than other bonds.
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Sovereign Debt
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Sovereign debt is the debt obligation of a foreign country. When another government wishes to borrow money, it will issue bonds like the United States does. In most cases, these bonds are considered riskier than U.S. government bonds, and have a higher yield. In fact, some countries are considered extremely risky, and have bond yields that are higher than those of American companies that are facing financial difficulty.
Who Buys Government Bonds
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Government bonds are usually bought by investors who want a safe, secure income without very much risk. They are often easier to understand than other forms of investment. Government bonds have been considered a "patriotic" form of investment in the past, since they represent both a way to give the country money now, and a way to bet that the country will continue to create wealth in the future.
Government bonds can also be traded in order to make a profit. Since they are often so safe from a credit standpoint (most governments pay their debt on time), these bonds' prices fluctuate based on other factors, such as interest rates. An investor wishing to express an opinion on interest rates may trade bonds to do so.
How Government Debt Fits Into a Portfolio
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Most investors have some government debt in their portfolios. Government debt is an easy place to "park" funds for later use. It is also a useful way to save money that an investor must have access to in the future. For example, in a college savings fund, money might be moved to government debt in the years immediately before it must be spent, to avoid the risk of other markets performing badly.
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References
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