Government Bonds

Government bonds are debt securities issued by federal, state, or local governments to raise funds for public spending. Investors who buy these bonds lend money to the issuer in exchange for periodic interest (coupon) payments and return of principal at maturity. Because they are backed by governments, these bonds are generally considered low-risk relative to corporate debt or equities.

Key takeaways

• Government bonds provide predictable income and return of principal at maturity.
• They come in several types with different maturities, tax treatments, and inflation protections.
• Prices move inversely to market interest rates; long-term fixed-rate bonds are most sensitive to rate changes.
• U.S. Treasuries are widely used as a benchmark for risk-free rates; foreign government bonds may carry higher sovereign or currency risk.

Main types of government bonds

• Treasuries (U.S. federal government)
• Treasury bills (T‑bills): Short-term (a few weeks up to 52 weeks), sold at a discount and redeemed at face value.
• Treasury notes (T‑notes): Intermediate-term (commonly 2, 3, 5, 7, or 10 years) with semiannual coupon payments.
• Treasury bonds (T‑bonds): Long-term (typically 20–30 years) with semiannual coupon payments.
• Treasury Inflation-Protected Securities (TIPS): Principal adjusts with inflation (based on CPI); pay a fixed rate applied to the inflation-adjusted principal. Common maturities: 5, 10, 30 years.
• U.S. savings bonds
• Series EE: Sold at face value; guaranteed to reach face value by a long-term horizon.
• Series I: Inflation-indexed with a composite rate that updates semiannually.
• Municipal bonds
• Issued by states, cities, and local agencies to fund public projects (infrastructure, schools, etc.). Many munis offer tax advantages at the federal—and sometimes state—level. They may be general obligation (tax-backed) or revenue bonds (paid from project revenues).
• Foreign government bonds
• Issued by other sovereigns (e.g., U.K. gilts, German bunds, Japanese JGBs). Yield and risk vary with the issuer’s fiscal position, political stability, and currency.

Key terms

• Face (par) value: Amount repaid at maturity.
• Coupon: Periodic interest payment based on the bond’s coupon rate and face value.
• Yield: Effective return on a bond accounting for purchase price and coupons.
• Market price: Current trading price on the secondary market, which may be above or below par.
• Interest rate risk: The risk that rising market interest rates will reduce the market value of existing bonds.

How bonds are issued and bought

• Primary issuance: Governments sell bonds through auctions. For U.S. Treasuries, primary dealers and other registered bidders participate; individual investors can acquire newly issued Treasuries via TreasuryDirect.
• Secondary market: Previously issued bonds trade among investors through brokers, exchanges, and over-the-counter markets. Prices fluctuate with interest rates and supply/demand.
• Indirect access: Investors can gain exposure through bond mutual funds and exchange-traded funds (ETFs), which offer diversification and easier trading.

Relationship to national debt and monetary policy

• Outstanding government bonds form a major component of a nation’s public debt—amounts owed to investors and other government accounts.
• Central banks use government bonds in open market operations. Buying bonds injects liquidity into the financial system (increasing the money supply), while selling bonds withdraws liquidity (decreasing the money supply), helping implement monetary policy.

Risks and considerations

Pros:
* Low credit/default risk for high-quality sovereigns (e.g., U.S. Treasuries).
* Predictable income and return of principal if held to maturity.
* High liquidity in major sovereign bond markets.
* Tax-advantaged options (certain municipal bonds) and inflation-protected securities (TIPS, I‑bonds).

Cons:
* Lower yields than riskier assets (stocks or high-yield corporate bonds).
* Interest rate risk: bond prices drop when rates rise, especially for long maturities.
* Inflation risk: fixed coupon payments lose purchasing power if inflation accelerates (unless inflation-protected).
* Sovereign and currency risk for foreign bonds, including potential default or devaluation.

Examples of non-U.S. government bonds

Common sovereign bond types include:
* U.K. gilts
* German bunds
* French OATs
* Japanese Government Bonds (JGBs)

Bottom line

Government bonds are a core fixed-income instrument for preserving capital and generating steady income. Choice of bond type depends on objectives (income, duration, inflation protection, tax treatment) and risk tolerance. For broad access and diversification, investors often use a combination of individual bonds and bond funds or ETFs.