How Government Bonds Work

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Government bonds are short, medium or long-term bonds, issued by public authorities and other government entities. As with any other bonds, default risk also exists with the government bond. The bonds are principally an obligation or a debt instrument generally issued in a local or foreign currency.

In the case of an issue involving a convertible currency of the concerned country or another, it is generally known as a sovereign issue. The bonds provide a continuous curve from which they can be risky but offer most valued financial assets (fixed rate bonds of other issuers, equities, interest rate swaps, etc).

T-Bills or Treasury Bills are short-term U.S. government bonds with a maturity of one month to one year. The T-Bills are among the most important instruments in the money market due to their high liquidity.

The calculation of interest on T-bills adheres to the day count convention which is always assumed on the basis of 360 days per year and not 365. T-bills are zero coupon bonds that are issued by auction in which the discount is determined accordingly.

Negotiable government debt of the United States was the first to reach a sufficient volume that grows around modern market interest rates. The U.S. Treasury is the author of many important innovations in this regard ahead of many countries in the world.

For example, the systematic issue by tender, use of primary dealers, issuance of bonds up to 30 years, regular issuance of securities in the medium term, breakup of bonds and bonds indexed to inflation.

American government bonds with a maturity between ten and thirty years are called T-Bonds. Risk associated with these bonds is estimated through rating agencies such as Moody’s. All government bonds of Austria, Finland, France, Germany, Ireland, the Netherlands and Spain, enjoy (as of December 2005), the highest credit rating awarded, after Moody’s Aaa.

Aa1 Belgium, Italy and Portugal with Aa2, and Greece with Baa3 (as of 2010) below the rating level. Depending on the creditworthiness of a state and its rating, the concerned State may be required to pay a risk premium on its government bonds.

The Japanese Treasury is a key borrower in the world, with a negotiable debt which exceeded the equivalent of 5,500 billion dollars in 2005. The Japanese government’s total debt amounted to 164% of GDP, a figure unique in the OECD.

The Japanese government bonds are called JGB, and they are essentially active on a domestic level, with only 4% of the outstanding JGBs being held by non-residents. The preponderance of Japan Post, very low rates and modest development, are all obstacles to the internationalization of this market.



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