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. Sovereign Bond Yield

    Sovereign bond yield is the interest rate paid on a government ...
  2. Global Bond

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

    Bonds issued by a national government in a foreign currency, ...
  4. Dollar Bond

    1. A U.S. denominated bond that trades outside of the United ...
  5. Government Bond

    A debt security issued by a government to support government ...
  6. Japanese Government Bond - JGB

    A bond issued by the government of Japan. The government pays ...
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

    How Exchange Risk Affects Foreign Bonds

    Investors include foreign bonds in their portfolios to take advantage of higher interest rates or yields, and to diversify their holdings. However, the higher return expected from investing in ...
  3. Investing

    Explaining Government Bonds

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

    Spice Up Your Portfolio With International Bonds

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

    Why Governments Issue Foreign Bonds

    Government bonds issued in foreign currency have drawn a growing amount of interest in recent years. This article explores why governments, particularly those in emerging markets, choose to denominate ...
  6. Insights

    How Countries Deal With Debt

    For many emerging economies, issuing sovereign debt is the only way to raise funds, but things can go sour quickly.
  7. Investing

    The Basics Of Investing In Foreign Government Bonds

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

    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.
RELATED FAQS
  1. 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 >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. Why is my bond worth less than face value?

    Find out how bonds can be issued or traded for less than their listed face values, and learn what causes bond prices to fluctuate ... Read Answer >>
  6. What types of investors are susceptible to interest rate risk?

    Learn how bondholders are more susceptible to interest rate risk than equity investors because of the direct correlation ... Read Answer >>
Hot Definitions
  1. Money Market

    A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. ...
  2. Block (Bitcoin Block)

    Blocks are files where data pertaining to the Bitcoin network is permanently recorded.
  3. Fintech

    Fintech is a portmanteau of financial technology that describes an emerging financial services sector in the 21st century.
  4. Ex-Dividend

    A classification of trading shares when a declared dividend belongs to the seller rather than the buyer. A stock will be ...
  5. Debt Security

    Any debt instrument that can be bought or sold between two parties and has basic terms defined, such as notional amount (amount ...
  6. Taxable Income

    Taxable income is described as gross income or adjusted gross income minus any deductions, exemptions or other adjustments ...
Trading Center