What Is A Government Bond?
A Government bond refers to debt security issued by a government to support government spending and other obligations. Because a government or a government entity backs them, government bonds are considered low risk. Most of them pay periodic interest payments while other government bonds are sold at a discount and do not pay coupons. They typically pay low-interest rates because of the relatively low risk involved.
Government bonds tend to differ from corporate bonds when it comes to liquidity. Liquidity is much lower for corporate bonds due to the higher number of government bonds issued. Comparing to the corporate bonds, the minimum investment required to invest in government bonds is much lower.
What is a benchmark bond?
A benchmark bond is a standard measure of an obligation’s return or risk compared to other measured bonds. These bonds are the most liquid and highly rated debts. They are used to measure the performance of portfolio managers and fixed-income investments. U.S. government’s T-Bonds are the most known and used benchmark debt securities in the world.
Who else is on the Bond Map?
The most risk-free government bonds issued in the world are usually by the U.S. Treasury Department. It sells issued bonds through auctions throughout the year. The low-risk profile often depends on the government, which backs the bond. Bonds from other countries thus may carry a higher degree of risk because they aren’t considered as secure as the U.S. Treasury.
Is presents an opportunity for some investors to cash in on government bonds from other countries. Government bonds from countries with a lower credit rating, such as those from Turkey and Egypt, can produce a significantly higher yield for investors compared to the US T-bonds. However, one has to always factor in the risks associated with it. For instance, the national currency of the country of which the investor is holding a bond may fall in price compared to USD. Decreasing the cost of the bonds in the investor’s possession, it leads to yield losses, sometimes even in the negative, for investors. It is called the currency risk factor.
Apart from the U.S. treasuries bond, the government bonds with the highest yields belong to emerging countries like Egypt, Brazil, Mexico, India, Ukraine, etc.
The Game Of Trust
Government bonds from nations with emerging markets carry substantial risks, which include central-bank risk, political risk, country risk, etc. It depends on several factors, including how solvent the banking system of the nation is. Despite this, some investors have sought out higher yields by investing in foreign government bonds, also known as sovereign debt. When the investor buys these bonds, he/she becomes the respective government’s lender or creditor. However, some risks are associated with this approach.
One of the first factors to determine whether to invest in a particular nation is its credit rating. There are three major credit rating agencies in the world, namely, Standard & Poor’s, Moody’s and Fitch. A Country with a higher rating would provide less of a risk when it comes to investing in their government bonds. It can be a comprehensive measure of trust for outside investors if they follow these international rating agencies’ credit ratings. The best ratings are “AAA” and “AA+,” while countries with the worst ratings are indicated by “S.D.,” “D,” and “CCC+.”
Credit rating list from Standard & Poor’s of the best-rated countries
Investors who are still interested in investing in government bonds from other countries must conduct proper research before selecting a particular country.
Research the Macro
To understand whether or not a country’s bonds are worth investing in, at least research specific macroeconomic indicators. These include inflation, rate of unemployment, GDP growth rate, and central bank interest rates.
- Inflation: Inflation may be considered as a bond’s worst enemy as it can erode the purchasing power of the bond’s future returns. The more inflation a country experiences, the lower the investor’s income becomes in value to USD.
- Rate of unemployment: A country’s unemployment rate is sometimes directly linked to the economic and governmental development the country is experiencing. Bonds from countries with higher unemployment rates are considered riskier. Their population total purchasing power is lower and the
- Growth of GDP: The GDP growth rate is a precise measurement of a country’s economic success. If the GDP growth is on a definite upward graph, investors can be optimistic about purchasing bonds from those countries.
- Central Bank Rate: Bonds are affected by monitory policy measures, including central bank key interest rates, buyout programs, money emission, and quantitative easing.
Countries experiencing political turmoil, including changing governments, unexpected election results, or problems in parliament, can influence investor sentiments. As seen in the list above, investing in bonds from countries with political instability involve a lot of risks. A perfect example would be the 2021 Bond from the Buenos Aires province, which plummeted in value before October 2019 as political instability increased.
Foreign Government bonds can provide a combination of great returns and liquidity, but comes with its own set of inherent risks which investors need to be aware of at all times.