What is a government bond?
A government bond is a security issued by a government. Its primary purpose is to cover government spending and pay down debt. For example, if the government needs money for infrastructure development, it issues bonds, inviting investments. Then, investors buy these bonds, and all the money raised goes to the government’s needs. Roughly speaking, a government bond is a loan from an investor to a government.
Why do investors buy government bonds?
The government pays periodic interest payments called coupon payments to those who purchased bonds. Besides, it will pay the principal at the specified maturity date. In this context, the principal is the amount of money the government borrows to return to the investor later. Maturity dates may range from one month to 30 years.
Government bonds issued are usually considered low-risk investments. The interest payments are typically low since the risk is minimal. Of course, the government should be credible and financially stable, so investors can be confident that the government will repay the money it took.
Treasury bonds vs. Government bonds
In the US, there are different types of government bonds. Treasury bonds are one of them. Treasury bonds or T-bonds are long-term bonds with a maturity between 10 and 30 years, issued by the US Treasury Department. Government bonds from the US Treasury are considered one of the most secure globally, while the bonds of other countries may be riskier. This is the reason why investors and analysts use Treasury bonds as a benchmark to compare the risk associated with other securities.
Types of government bonds
There are various types of bonds in the US, as mentioned above. Why do we consider only US bonds? Their yields tend to have the most impact on the major currency pairs in the Forex market. US bonds can be divided into four main categories. They differ by maturities. Besides, some bonds make interest payments regularly, while others do not
- Treasury bills mature in less than one year.
- Treasury notes are bonds maturing in two, three, five, or ten years that provide fixed coupon returns.
- Treasury bonds are longer-term bonds, with a maturity date that’s more than ten years and less than 30 years.
- Treasury inflation-protected security (TIPS) is a Treasury security indexed to inflation.
Government bond example
10-year Treasury notes are the most important bonds to track for traders.
The yields of 10-year Treasury notes perform as an indicator of the market expectations for the US interest rate changes. Besides, the dynamics of the yields can be driven by the market uncertainty or the risk-off sentiment when investors park their capital in less risky assets like bonds rather than buying risker assets like stocks.
- When the yields are increasing, the US dollar tends to rise.
- When the yields are decreasing, the US dollar tends to fall.
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