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. What are the benefits of government bonds?

    Its true for the fact that it is one of the safest instruments to invest, but do you really get the rate of return over a ... 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. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>
Related Articles
  1. Markets

    Explaining Government Bonds

    A government bond is a debt security a government issues.
  2. Financial Advisor

    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. Managing Wealth

    Six Biggest Bond Risks

    Don't assume that you can't lose money in this market - you can. Find out how.
  4. ETFs & Mutual Funds

    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. ...
  5. Personal Finance

    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.
  6. Managing Wealth

    5 Basic Things To Know About Bonds

    Learn these basic terms to breakdown this seemingly complex investment area.
  7. Trading

    Top 6 Uses For Bonds

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

    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.
  9. Investing

    Understanding Credit Risk

    Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt.
  10. Markets

    How Risk Free Is The Risk-Free Rate Of Return?

    This rate is rarely questioned - unless the economy falls into disarray.
RELATED TERMS
  1. Federally Guaranteed Obligations

    A federally guaranteed obligation is debt that is backed by the ...
  2. Government Bond

    A debt security issued by a government to support government ...
  3. Full Faith And Credit

    A phrase used to describe the unconditional guarantee or commitment ...
  4. Government Security

    A bond (or debt obligation) issued by a government authority, ...
  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. ...
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center