A government bond is a bond issued by a national government, generally promising to pay a certain amount (the face value) on a certain date, as well as periodic interest payments. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country. Government bonds are usually denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds[1], although the term "sovereign bond" may also refer to bonds issued in a country's own currency.
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The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France. It was in the form of a tontine. Later, governments in Europe started issuing perpetual bonds (bonds with no maturity date) to fund wars and other government spending. The use of perpetual bonds ceased in the 20th century, and currently governments issue bonds of limited duration.
Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or create additional currency in order to redeem the bond at maturity. Some counter examples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998 (the "ruble crisis"), though this is very rare (see national bankruptcy). Another example is Greece in 2011. Its bonds were considered very risky, in part because Greece did not have its own currency.
As an example, in the US, Treasury securities are denominated in US dollars. In this instance, the term "risk-free" means free of credit risk. However, other risks still exist, such as currency risk for foreign investors (for example non-US investors of US Treasury securities would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation risk, in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation rate is higher than expected. Many governments issue inflation-indexed bonds, which protect investors against inflation risk by increasing the interest rate given to the investor as the inflation rate of the economy increases.
In the UK, government bonds were called "government stock" or "treasury stock" and the older issues are still called "treasury stock".[2] Newer issues are called "gilts".[3] The name "bond" was reserved for fixed-value investments, which were not tradeable on the stock market. Inflation-indexed bonds are called Index-linked gilts in the UK.[4]
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