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Investing in Government Bonds

By Edited Apr 27, 2015 0 0

Government and municipal bonds can be a totally different beast from corporate bonds. The primary reason for this is that government bonds are often backed by the full faith and credit of the issuing government. If a government runs out of money, it has the ability to simply raise taxes to collect the needed funds.

Defaults on government bonds are far more rare than defaults on corporate bonds. Furthermore, even in the usual event when a government does default on its bonds, bondholders frequently get the majority of their money back.

Government bonds can be attractive to high net worth individuals, since government bonds may enjoy special tax-exemptions within certain jurisdictions. For example, in the U.S. the interest paid on certain U.S. government bonds is exempt from local, state, and/or federal taxation.

It is important to understand the terms of the particular government or municipal bond issue that you are planning to invest in. If the bond is only backed by the revenues from a specific project then you have a much more risky bond than one backed directly by a government.

If a bond is backed only by a specific project, then you have to evaluate the prospects for that project in terms of its ability to generate funds to pay interest and repay principal. You also have to evaluate what recourse you may have as a bondholder if there is a default on the bond. Sometimes governments will step in to repay bondholders even if they are not specifically required to. But in other cases, you could simply be out of luck to recover only what it specified in the bond contract.

The most popular government bonds in the world are U.S. Treasury bonds. Treasuries are currently considered to be the safest investment that one can make. As a result of this, Treasuries tend to pay very low interest rates.

U.S. Treasuries are one of the few bonds that can be easily bought by individual investors. The Treasury maintains a website called Treasury Direct, where individuals can go to bid on new issues of Treasury bonds directly from the U.S. government. Using this method, investors can avoid all brokerage fees and markups. However, if an investor wishes to sell before the bond’s maturity date, it may still be necessary to pay a brokerage commission in order to dispose of the bond in the secondary market.

Governments all around the world issue bonds, normally denominated in their domestic currency. Buying foreign government bonds can be interesting to some investors since the bonds offer higher yields. However, these higher yields also come with a higher risk of default.

In addition, buying government bonds issued in other currencies can subject you to foreign exchange risk. Simply put, this means that you may gain or lose money based on how the exchange rate between the foreign currency and your home currency changes. In addition, you may incur fees when you convert payments in a foreign currency into your home currency.

Government bonds can be an interesting investment, sometimes offering increased safety over corporate bonds. However, you should study each bond carefully to make sure you understand the special features of each bond that you are investing in. 



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