What is a 'Sovereign Bond'

A sovereign bond is a debt security issued by a national government. Sovereign bonds can be denominated in a foreign currency or the government’s own domestic currency; the ability to issue bonds denominated in domestic currency tends to be a luxury that most governments do not enjoy. The less stable of a currency denomination, the greater the risk the bondholder faces.

BREAKING DOWN 'Sovereign Bond'

The government of a country with an unstable economy tends to denominate its bonds in the currency of a country with a stable economy. Because of default risk, sovereign bonds tend to be offered at a discount.

The default risk of a sovereign bond is assessed by international debt markets and represented by the yield the bond offers. Bondholders demand higher yields from riskier bonds. To illustrate, as of May 24, 2016, 10-year government bonds issued by the Canadian government offer a yield of 1.34%, while 10-year government bonds issued by the Brazilian government offer a yield of 12.84%. This spread of 1150 basis points accounts for the financial position of both governments, and is indicative of the favorable credibility enjoyed by the Canadian government.

Sovereign Bonds Denominated in Foreign Currencies

As of 2014, the most recent year such data is available, debt denominated in the five largest global currencies, the U.S. dollar, the British pound, the euro, the Swiss franc and the Japanese yen, accounted for 97% of all debt issuance, but only 83% of this debt was issued by these countries. The reality is less-developed countries have difficulty issuing sovereign bonds denominated in their own currency, and thus have to assume debt denominated in a foreign currency.

This is due to a number of reasons. First, investors consider poorer countries to be ruled by less-transparent governments that are more susceptible to corruption, increasing the likelihood of loans and government investments being funneled into unproductive areas. Second, poorer countries tend to suffer from instability, leading to higher rates of inflation, which eats into the real rates of return received by investors.

Therefore, less-developed countries are forced to borrow in foreign currencies, further threatening their economic situation by exposing them to currency fluctuations that can make their borrowing costs more expensive. For example, say the Indonesian government issues bonds denominated in yen to raise capital. If the interest rate it agrees to borrow is 5%, but over the duration of the bonds’ maturity, the Indonesian rupiah depreciates by 10% in relation to the yen, then the real interest rate the Indonesian government has to pay in the form of principal and interest payments is 15%, assuming its business operations are conducted in rupiah.

RELATED TERMS
  1. Global Bond

    This type of bond can be traded in a domestic or European market. ...
  2. Sovereign Debt

    Bonds issued by a national government in a foreign currency, ...
  3. Government Bond

    A debt security issued by a government to support government ...
  4. Foreign Bond

    A bond that is issued in a domestic market by a foreign entity, ...
  5. Japanese Government Bond - JGB

    A bond issued by the government of Japan. The government pays ...
  6. Dragon Bond

    A fixed income security issued by a firm in an Asian nation, ...
Related Articles
  1. Investing

    The Risks Of Sovereign Bonds

    Sovereign debt can play an important role in providing international diversification to individual investors.
  2. Investing

    Explaining Government Bonds

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

    Spice Up Your Portfolio With International Bonds

    Going global can add flavor and diversity to an otherwise bland basket of bonds.
  4. Investing

    The Basics Of Investing In Foreign Government Bonds

    Individuals contemplating the purchase of government bonds need to understand the risks of bond investing.
  5. Investing

    An Introduction To Emerging Market Bonds

    The rewards associated with this fixed-income asset are significant, but so are the risks.
  6. Insights

    Sovereign Debt Overview

    The national or government debt is a combination of both internal and external debt. The external debt is referred to as Sovereign Debt. Sovereign Debt refers to bonds issued by a nation’s ...
  7. Investing

    Top 4 International Treasury Bond ETFs (BWX, EMB)

    Learn about the top four international treasury bond funds that hold sovereign foreign bonds, which can be denominated in U.S. dollars and local currencies.
  8. Retirement

    Why Your Pension Plan Has Sovereign Debt In It

    One type of security pensions tend to invest in is sovereign debt, or debt issued by a government.
  9. Investing

    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.
RELATED FAQS
  1. 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 >>
  2. What are the key factors that will cause a bond to trade as a premium bond?

    Learn about the primary factor that can cause bonds to trade at a premium, including how national interest rates affect bond ... Read Answer >>
  3. Who are the key players in the bond market?

    The bond market can essentially be broken down into three main groups: issuers, underwriters and purchasers. The issuers ... Read Answer >>
  4. What determines the price of a bond in the open market?

    Learn more about some of the factors that influence the valuation of bonds on the open market, and why bond prices and yields ... Read Answer >>
  5. Which factors most influence fixed income securities?

    Learn about the main factors that impact the price of fixed income securities, and understand the various types of risk associated ... Read Answer >>
  6. How does face value differ from the price of a bond?

    Discover how bonds are traded as investment securities and understand the various terms used in bond trading, including par ... Read Answer >>
Hot Definitions
  1. 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 ...
  2. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  5. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
  6. Buyback

    The repurchase of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies ...
Trading Center