Loading the player...

What is a 'Government Bond'

A government bond is a debt security issued by a government to support government spending. Federal government bonds in the United States include savings bonds, Treasury bonds and Treasury inflation-protected securities (TIPS). Before investing in government bonds, investors need to assess several risks associated with the country, such as country risk, political risk, inflation risk and interest rate risk, although the government usually has low credit risk.

BREAKING DOWN 'Government Bond'

Because most government bonds are backed by the credit of the U.S. government, default is unlikely and government bonds are considered essentially risk-free. Thus, government bonds create a benchmark against which riskier securities may be compared.

Pros and Cons of Government Bonds

Government bonds are considered risk-free and are traded in highly liquid markets. Certain government bonds restrict the dollar amount that may be purchased per calendar year. On the downside, government bonds return a typically low rate of return. Only select bonds offer protection against inflation, which may outpace the bond's interest rate. Also, government bonds have minimal capital gain opportunities. Government bond prices are tied to interest rates, so government bonds with fixed rates will incur interest rate risk as fluctuations in interest rates may cause a decline in value of the bond.

Control of the Money Supply

Government bonds assist fund deficits in the federal budget and control the nation's money supply. When the government repurchases its own bonds, the money supply increases as sellers receive funds to utilize in the market. Eventually, when funds are deposited into a bank, financial institutions utilize the money multiplier to expand the money supply. Alternatively, the government can also sell bonds that reduce the money supply as buyers are forgoing the ability to hold money now for future economic benefit. The government receives cash for its bonds and may proceed in retiring the cash to restrict the money supply if it chooses.

Types of Treasury Savings Bonds

The U.S. Treasury offers two types of savings bonds. The first is called a Series EE bond. Sold at half its face value, all Series EE bonds receive a fixed and stated rate of interest. However, if the bond is held for 20 years, the value of the bond will double and result in an effective pre-tax interest rate of 3.53%.

Series I bonds receive interest based on two figures. The first relates to a fixed rate of interest established periodically. The second is a rate tied to an inflation rate calculated on a biannual basis.

RELATED TERMS
  1. Fixed-Rate Bond

    A fixed-rate bond is a bond that pays the same amount of interest ...
  2. Bond ETF

    Bond ETFs are very much like bond mutual funds in that they hold ...
  3. Savings Bond Plan

    A savings bond plan allows employees to purchase U.S. savings ...
  4. Dollar Price

    Dollar price is a method of pricing a bond in value terms, not ...
  5. Fixed-Income Security

    A fixed income security is an investment that provides a return ...
  6. Bond Rating

    A bond rating is a grade given to bonds that indicates their ...
Related Articles
  1. 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.
  2. Investing

    Using U.S. Savings Bonds As a Long-term Investment

    A 20-year Series EE savings bond pays more interest than a 20-year Treasury bond. Government-issued long-term bonds might not always be the best choice.
  3. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
  4. Investing

    The Best Bet for Retirement Income: Bonds or Bond Funds?

    Retirees seeking income from their investments typically look into bonds. Here's a look at the types of bonds, bond funds and their pros and cons.
  5. Investing

    5 Fixed Income Plays After the Fed Rate Increase

    Learn about various ways that you can adjust a fixed income investment portfolio to mitigate the potential negative effect of rising interest rates.
  6. Investing

    Six biggest bond risks

    Bonds can be a great tool to generate income, but investors need to be aware of the pitfalls and risks of holding corporate and/or government securities.
  7. Investing

    U.S. Corporate Bonds: The Last Safe Place to Make Money

    There aren't many other sources right now for relatively safe, steady income.
  8. Retirement

    Should I Invest in Bonds After I Retire?

    Yes, retirees should invest in bonds, but remember that not all bonds are safe investments. Seek the help of a financial advisor.
RELATED FAQS
  1. Where can I buy government bonds?

    The type of bond dictates its purchase. Federal bonds are issued by the federal government, while municipal bonds are issued ... Read Answer >>
Trading Center