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Government Bonds: Risks and Rewards

It's often said that government bonds represent one of the lowest possible risks for an investor. In general, true - but much depends on which government issues them and which investor is buying.

Government bonds are usually sold with the wording 'Backed by the full faith and credit of the...' So, estimating the risk becomes an exercise in determining how much faith one places in that credit.

The Iran government floats bonds targeting foreign investors, and some have profited, for example. But investing in a country likely to see significant political change at any time is taking a high risk. The investor, whether native or foreigner, generally has no recourse if the issuer defaults.

That said, there are a wide variety of choices for the investor seeking low risk investments that offer a modest return.

U.S. Treasuries

Bonds issued by the U.S. Treasury (hence the name) are rightly considered among the lowest risk investments. To date, they've never defaulted and there's small likelihood they will anytime in the foreseeable future. Like any government issued bond, they're backed by the ability to levy and collect income tax (or inflate the currency in order to lower the actual repayment cost) - an ability they're unlikely to lose anytime soon.

T's come in a variety of maturities (length before principal is repaid) and coupon (interest) rates.

Treasury Bills (13, 26 or 52 weeks) are auctioned on Mondays and the 52-week sells every four weeks. Minimum purchase amount is $1000, with interest paid at maturity for the 13 and 26 week, and at the half-way point and maturity for the 52 week.

Treasury Notes are intermediate length bonds with maturities of 2-year, 5-year and 10-years, again sold in minimum amounts of $1000. Two-years are sold monthly, 5 and 10-year notes every three months starting in February. Like most bonds, interest is paid semi-annually.

Treasury Bonds of the 30-year variety are available in February, August and November at $1000 each with interest paid every six months.

Once sold their price will vary on the open market as buyers and sellers bid and compare against other similar instruments. Longer-term bonds tend to have greater price changes than shorter-term bonds, owing to a number of factors including the uncertainty of future interest rates, general economic forecasts and political events, etc.

To calculate the current yield (as with any bond) divide the interest rate by the current price. For example, a $1000 bond that pays $46 per year in interest is $46/$1000 = 0.046 = 4.6%.

Since the coupon rate is fixed, this could have been read without being calculated. But, bond prices vary from par (face) value. So, even if the coupon rate were 4.6% if the bond sells 'under 100', i.e. at a discount to it's original price, the yield can, and usually does, differ from the interest rate. A $1000 bond that sells for $950, for example, with a coupon rate of 4.6% will yield: 46/950 = 4.8%.

For investors looking for predictable cash flow at low risk, government bonds - whether U.S., Canada, UK, Germany, or other stable country - represent a viable investment.