A:

For any debt obligation to be considered completely risk-free, investors must have full faith that the principal and interest will be paid in full and in a timely manner. The faith aspect of a debt obligation is measured by a country's credit rating. Much like an individual's credit rating is determined by his or her borrowing and repayment history, so too are governments' financial histories scrutinized. From time to time, governments will borrow funds from other countries and investors through loans and bonds. The servicing and repayment of these bonds are carefully measured by financial institutions for creditworthiness. Specifically, these financial institutions look at a government's lending and repayment history, the level of outstanding debt and the strength of its economy.

One of the most popular credit rating companies, Standard and Poor's, has given the U.S. government its highest possible rating: AAA. Because U.S. government bonds are backed by the U.S. government and the U.S. has the most powerful economy in the world, these bonds are widely considered to be risk-free. When you purchase this type of bond, the U.S. government is guaranteeing that the interest and principal will be paid according to the bond covenants. That is, they are guaranteeing that payments will be paid on time and in full.

Only a monumental downturn in the economy or, possibly, a very rare circumstance during a time of war would prevent the U.S. government from repaying its short- or long-term debts. However, even such events are unlikely to result in the U.S. government defaulting, since it has the ability to print additional money (monetary policy) or increase taxes (fiscal policy) if additional capital is needed.

(To learn more about federal bond issues, check out our article Basics of Federal Bond Issues.)

RELATED FAQS
  1. In the context of a bond, what does the principal refer to?

    Get introduced to the world of bond investing and learn what the term "principal" means in reference to a corporate or government ... Read Answer >>
  2. What forms of debt security are available for the average investor?

    Discover the various different types of debt securities, issued by government entities or corporations, that are available ... Read Answer >>
  3. How is it possible for a rate to be entirely risk-free?

    Find out whether there really is such a thing as a risk-free rate of return, and learn why taking the idea of risk-free rates ... Read Answer >>
  4. What nations other than the U.S. have risk-free interest rates?

    Find out which countries have risk-free rates of returns. This is typically the yield on a 3-month note, and it can be negative ... Read Answer >>
  5. Where can I buy government bonds?

    The type of bond determines where you can purchase it, so you need to decide which type of bond you would like to purchase ... Read Answer >>
  6. How is bond yield affected by monetary policy?

    Learn about how bond yields are affected by monetary policy. Monetary policy determines the risk-free rate of return, which ... Read Answer >>
Related Articles
  1. Bonds & Fixed Income

    Explaining Government Bonds

    A government bond is a debt security a government issues.
  2. Investing

    Advising FAs: Explaining Bonds to a Client

    Most of us have borrowed money at some point in our lives, and just as people need money, so do companies and governments. Companies need funds to expand into new markets, while governments need ...
  3. Bonds & Fixed Income

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  4. Home & Auto

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  5. Bonds

    What bonds are: Debt securities where you lend money to an issuer (e.g., a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value. ...
  6. Professionals

    Introduction To Bonds

    We look at what bonds are and how to buy and sell them.
  7. Options & Futures

    Top 6 Uses For Bonds

    We break down the stodgy stereotype to see what these investments can do for you.
  8. Retirement

    Analyzing The Best Retirement Plans And Investment Options: Bonds

    What they are: Debt securities in which you lend money to an issuer (such as a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value. ...
  9. Professionals

    The Bond Market

    We look at the market where debt securities are issued and traded.
  10. Bonds & Fixed Income

    Why Bad Bonds Get Good Ratings

    Credit ratings are not the only tool to rely on when assessing bonds. Find out why they sometimes fall short.
RELATED TERMS
  1. Government Bond

    A debt security issued by a government to support government ...
  2. Federally Guaranteed Obligations

    A federally guaranteed obligation is debt that is backed by the ...
  3. Government Security

    A bond (or debt obligation) issued by a government authority, ...
  4. Full Faith And Credit

    A phrase used to describe the unconditional guarantee or commitment ...
  5. Japanese Government Bond - JGB

    A bond issued by the government of Japan. The government pays ...
  6. Sinking Fund

    A means of repaying funds that were borrowed through a bond issue. ...

You May Also Like

Hot Definitions
  1. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  2. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  3. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  6. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
Trading Center