Government Bond

As a bond issued by a governing entity, a Government bond assures time bound interest payments. A Government bond also guarantees encashment for a certain amount upon completion of a fixed period. The idea of a bond is like a loan, where the customer lends his money to the government or an authorized organization. This is done through a pre-determined arrangement regarding the time for loan and the amount of interest due, on completion of that time. Normally such bonds are issued in local currencies. However, these bonds are called Sovereign bonds, when they are issued in currencies other than the local currency. However, all Sovereign bonds are not always issued in foreign currency only, and sometimes bonds in local currency are also called Sovereign bonds.

Great Britain was the first country to issue government bonds back in 1693. The bank of England was tasked to arrange funding for the war against the French, through these bonds. The initial bonds were a mix of both lottery and annuity. Other governments in the region followed suit and issued their own versions of the bonds called Perpetual bonds, bonds with no maturity date. However, governments stopped issuing Perpetual bonds from the beginning of the 20th century and instead Government bonds with stated maturity dates were issued.

Risk of default on Government bonds

Government bonds are considered a risk free investment, since these bonds are backed by governmental guarantees. Governments have the power to fund the encashment of these bonds on reaching maturity through levies and tolls, or by simply printing more money. Russia is a rare example of a country that defaulted on its own internal loans back in 1998. Greece is perhaps another example to default on its Government bonds in 2011, but Greece does not have its own currency.

Other Risks attached to Government Bonds

Like all other countries, the United States issues such bonds and securities in its own currency the dollar. Being risk free in terms of these bonds, means free from the risk of default, but some other risks do exist, especially for non local prospectors. If the value of the currency of the bond depreciates against the investors own currency, the result would be less returns on the bonds in terms of his own currency. This is what happened in 2004 to foreign investors, when US dollar fell against many foreign currencies.

Another risk is the inflation, if the inflation rate is very high, then the encashment amount may well end up with less buying power then the initial investment. To counter the inflation risk, an inflation indexing option is attached with the bonds, thereby automatically increasing the rate of interest against the rise in inflation.

Terminologies used in Britain

Britain, being the pioneer of these bonds also came up with different terminologies for them; initially called Government or Treasury stock, later issues were called Gilts. Those Stocks or Gilts that cannot be traded on the stock exchange and hold a pre-determined value are called Bonds. Whereas, the Bonds with inflation indexing option are called Index-Linked Gilts.