Government bond

A government bond or sovereign bond is a form of bond issued by a government to support public spending. It generally includes a commitment to pay periodic interest, called coupon payments, and to repay the face value on the maturity date. The ratio of the annual interest payment to the current market price of the bond is called the current yield.

For example, a bondholder invests $20,000, called face value or principal, into a ten-year government bond with a 10% annual coupon; the government would pay the bondholder 10% interest ($2000 in this case) each year and repay the $20,000 original face value at the date of maturity (i.e. after ten years).

Government bonds can be denominated in a foreign currency or the government's domestic currency. Countries with less stable economies tend to denominate their bonds in the currency of a country with a more stable economy (i.e. a hard currency). International credit rating agencies provide ratings for each country's bonds. Bondholders generally demand higher yields from riskier bonds; for example, during the Greek government-debt crisis, the spread (difference) in yields between two and ten-year Greek and German government bonds peaked at 26,000 and 4000 basis points, respectively.

Governments close to a default are sometimes referred to as being in a sovereign debt crisis.

One of the first assets resembling government bonds were the forced loans, or prestiti, that the Republic of Venice first issued in 1172 to fund wars and defence spending. These paid a nominal interest rate of 5% per year on the face value, in two half-yearly instalments, and could be sold in the open market for a lump sum.

In 1694, William III of England used a syndicate of 1268 investors to purchase debt to fund the Nine Years' War. This syndicate was granted a Royal charter, becoming the Bank of England. Much of the initial debt issuance by the English government took an unconventional form by current standards, including annuities and lotteries as parts of their design, but alongside these were a number of perpetual bonds offering different coupon rates, and by 1752 these perpetual bonds were consolidated (consols) in a smaller number of distinct stocks offering fixed coupon payments, and the bond market took a more recognisably modern form.

In the United States of America, bonds date back to the American Revolution, where private citizens purchased $27 million of government bonds to help finance the war. Today, the market for US government bonds (known as US Treasury securities) is the largest and most liquid market for government securities in the world, averaging $900bn in transactions per day.

A government bond in a country's own currency is strictly speaking a risk-free bond, because the government can if necessary create additional currency in order to redeem the bond at maturity. There have been instances where a government has chosen to default on its domestic currency debt rather than create additional currency, such as Russia in 1998 (the "ruble crisis"). Furthermore, if a government bond is issued in a foreign currency then the government cannot simply create additional currency to redeem the bond, but must instead use its foreign currency reserves.