The Financial Risks of Government Bonds

Government bonds are considered to be least-risk investments. They are backed by the full faith and credit of the government. Standard & Poor’s gives U.S. government bonds the highest rating possible. Government bonds carry some financial risks, just like any other investment.

Federal government bonds have a low risk of default because the government can always:

  • Raise taxes to pay debts
  • Borrow money from other countries
  • Print more money

This does not mean that is impossible for the U.S. government to have a hard time paying back bonds. Though unlikely, if there is a devastating wartime or financial crash, the government may not be able to repay at the promised time. And, as always, there is a market risk for any type of investment. Remember that bonds are subject to interest rates. You could buy a 20-year bond at 4% interest and tomorrow (or even 5 years from now) the same bond could rise to a 6% interest rate.

State and local government bonds are considered more risky than Federal bonds. They offer more competitive interest rates because they can go bankrupt. These municipal bonds also allow bondholders to be exempt from taxes.

There are some instances where State governments have had issues:

1. Orange County, CA: In 1994, the Orange County, CA municipality filed for bankruptcy. The county treasurer, Bob Citron, devised a plan to invest deposits from the County Investment Pool. This pool was made up of monies from the county government and about 200 public agencies. He invested in derivatives, inverse floaters, and long term bonds that paid high yields with this money. He borrowed against the borrowed money and lost the county about $1.64 billion dollars. The banks he borrowed from began to seize the assets of the County Investment Pool and the county filed for bankruptcy. All of the bondholders of the O.C. were out of luck.

2. Cleveland, OH: In 1980, the capital declared a fiscal emergency which also applied to all municipalities in Ohio. For years, their general fund expenses exceeded their revenue and they could not issue, refinance, renew, or repay notes. They had to borrow $15 million dollars from the State of Ohio to pay its debts on the condition that their financial progress would be monitored by the State.

Basically, federal bonds are less risky than municipal bonds but both trump that of the general market. Because they either can borrow money or raise taxes (sigh) it is more likely that you will be paid back your money in the instance of default.

Basics of United States Government Bonds

Government bonds are an investment like and unlike any other bond.

Like corporate bonds, which may be used instead of public stock offerings to fund corporate expansions, U.S. government bonds are issued to, “help to finance the federal government”, which as you know is a vast enterprise. As long as elected government officials refuse to cut spending, or raise sufficent revenue by raising taxes, bonds will and must be sold by governments to meet their expenses. Fortunately, in the realm of government bonds, those issed by the United States are “…considered to be some of the safest you can buy” – at least for the foreseeable future.

As reflected by the recent public-government debt crisis in the nation of Greece not all governments are as reliable and secure in the prospect of the government paying or repaying their debts. However, in most cases, government bonds tend to be the safest type of bond offered anywhere, in any market.

To purchase a treasury bond an investor pays an initial price that can be at, higher or lower than the face value of a bond.

After purchase a treasure bond will “…pay interest every six months until they mature”. T-bonds have a set “maturity”, that is, a time of up to 30 years after which an invertor holding the T-bond is “paid its face value”.

The same set of facts that offer security to investors simultaneously limit or reduce the investor’s profit margins when investing in government bonds. The high level of security (in the principal or face amout of government bonds) is attributable to the bond’s backing by the “full faith and credit” of the United States taxpayers. As in the case of most investments the trade-off for security or “low risk” is moderate returns.

Government bonds, because of their high level of security, can be used to diversify investment portfolios and minimize risk for those looking to preserve capital, that is, one’s assets. This may be particularly true for babyboomer or those approaching retirement and wishing to have greater certainty about their ability to fund the lifestyle in retirement.

Another drawback, besides modest yields, is the long time it takes for a bond to mature since the principal investment cannot be regained until the bond is retired at its maturity. This can be up to 30 years down the line unless the bond is resold.

The trading of bonds, pending maturity, will likely result in a transaction fee paid to a broker or a bank, effectively reducing the money that they would otherwise have been received if the investor held the bond until maturity.

There are even new “…inflation-indexed bonds (I-bonds) which were created to reassure investors by helping to protect I-bond purchasers from the effects of future inflation. I-bills are ideal for those who are content with safe, small returns, regardless of inflation.

If interested, one can, “purchase some U.S. bonds through brokers and banks or directly through the Federal Reserve Banks”.

By – Domenic Gabriella

The Basic Types of Federal Government Bonds and Bills

As far as choice goes, the federal government offers an array of bonds, treasuries and other investment options to any US citizen. Of the bonds offered, the more commonly purchased are government bonds, T-bills, and I-bonds.

Thanks to Federal government’s reputation of having, “…never failed to pay its debt” government bonds are considered the safest of the bond investments. Of course, it would be quite surprising to see the federal government default on a debt when they also have the power to print more money.

These bonds are normally, “…issued in terms of 30 years and pay interest every six months until they mature”.

The cost or price of government bonds is typically whatever market rate the market “demands”, that is, what price the informed public is willing to pay. Thus the price can be any of three options; equal to the face value if the bond and market return are equal, higher if the bond offers a higher return than the market risk requires, or less if the bond is offering less than the market expects for the risk. When one feels their investments in the market are too risky and they are too venerable to a recession could always purchase these to help minimize such fears.

T-bills are another investment option the federal government sells. These bonds mature, “…in one year or less” and are always sold at a “discount from their face value”.

All profit from purchasing a T-bill comes from the difference in the face value and the actual cash amount paid for the T-bill. There are no interest payments on the T-bills.

I-bonds or inflation-indexed bonds, offer a way to “…help protect against inflation”, . In one form or another, inflation indexed bonds, “comprise over $1.5 trillion of the bond market.

By – Domenic Garbriella