Government bonds as a tool to reduce the consequences of the economic crisis
Higher risk - higher profitability, and vice versa - the rule of the market. Therefore, in the situation of great uncertainty, interest in reliable assets, instruments that help to minimize the negative consequences of the crisis is natural. One of the least risky assets is government obligations or bonds. They help to save money and get moderate income with relatively low risks.
What are bonds and obligations?
Obligations (bonds, from the English bond) are valuable papers issued by the issuer (creditor), borrowing money from the buyer at interest. Accordingly, the investor purchases bonds, counting on income generation.
The bonds will be repaid within the specified period. Allocate short-term - for a repayment period of less than a year, medium-term - from 1 to 5 years and long-term - more than 5 years. Extremely rare, but there are also perpetual bonds. The payment of income on them is made regularly, but the issuer may never repay them (pay the nominal value). At the same time, he usually has the right to redeem them at face value on certain dates - for example, once every five or ten years.
Sourse: Bank of Russia
As a rule, the longer the paper - the higher the yield. But sometimes there is an inversion of the yield curve - the yield of short-term bonds is higher than the yield of long-term ones. This suggests that the risks of investing in the short term are greater than the risks of investing in the long term.
Bond yields also depend on the issuer's credit rating. The more reliable the borrower, the lower the yield. The higher the rate, the greater the risks.
The issuer can be both government bodies and companies. But in this article we will focus exclusively on the state.
Treasuries, US bonds
The most reliable asset in the stock market is considered to be American Treasury bond. They are also called “treasuries” because they are issued by the US Treasury.
Source: Investing.com
US Treasuries are traded on the primary and secondary markets. They have high liquidity but low profitability. Treasuries are most often owned by other states, large funds, and insurance companies. For private investors, US bonds are of interest only as an instrument of protection against inflation.
Source: Investing.com
Source: Investing.com
Eurobonds
This title can be a bit confusing. Eurobonds are not necessarily issued by European countries or issued in euros. Moreover, bonds, for example, Germanic ones, issued in euros are not Eurobonds. And Russian bonds in US dollars are Eurobonds.
Eurobonds are all bonds issued in foreign currencies. The name is historical. In 1963, the Italian motorway network Autostrade issued bonds denominated in American dollars to circumvent the US interest rate equalization tax. This was the first time when bonds were issued in foreign currency.
The main feature of Eurobonds is that in addition to income from a change in the price of a bond, you can earn on the difference in rates. Of course, with a favorable change in rates for the investor.
Interest and discount bonds
According to the type of income, we can differentiate between interest and discount bonds.
On interest-bearing bonds, the issuer pays periodic interest (coupon) during the period of circulation of the bond. Depending on the condition, payments can be made once a month, quarter, year.
Interest-bearing bonds with a fixed, variable and floating coupon are allocated. In the first case, the rate is known since its release and, as a rule, is the same for the entire period of circulation of the paper.
Variable coupon is fixed until the date of the offer, after which it changes depending on market conditions. Before the offer, the new interest rate is unknown. Such a mechanism allows the borrower to reduce interest rate risk, and the bondholder has the opportunity to redeem the offer prematurely.
A floating interest rate is tied to the change in some indicative financial instrument, such as a discount rate.
The yield on discount (zero-coupon) bonds is defined as the difference between the security purchase price and the redemption/sale price. The price of redemption of bonds at the appointed time is known in advance. The earlier the bond is purchased, the cheaper it will be. As the deadline approaches, the price rises.
How to invest in government bonds?
As a rule, citizens can purchase bonds issued by government bodies of their countries without any problems in banks and other financial institutions.
Authorized resellers are needed to purchase foreign bonds.
So, in order to purchase US Treasuries, private investors need to open a brokerage account with a company that has access to the US stock market.
Risks of investing in government bonds
Risks when investing in bonds are much less than when investing in stocks and other securities, but are still there.
Inflation risk is the risk that inflation will exceed the yield on a bond.
Default risk. This happens infrequently with states, but nevertheless this has happened more than once in history.
Liquidity risk is the risk in the situation where you decide to sell bonds before maturity, but do not find a buyer close to the nominal.