Reviewed by Aug 26, 2020| Updated on
A sovereign bond, or a government bond, is a specific debt instrument issued by the government. You can avail it in both foreign currency and domestic currency. The sovereign bond yield is the interest rate paid on a government sovereign bond. That is sovereign bond yield is the rate of interest at which a national government can borrow. They are sold by governments to raise money for spending for purposes such as financing finance war efforts.
Similar to other bonds, sovereign bonds offer a precise interest for a specified number of years on the purchase amount. It repays a face value upon maturity. A rating will be mentioned on them that defines the creditworthiness of the bonds. The government offers such bonds to meet their financial needs for expenditure as this is similar to taking loans from the market.
Understanding Sovereign Bond
The difference between sovereign bond yield and corporate bond yield is used as a measure of the risk premium placed on corporations. It is important to analyse these factors when considering an investment in sovereign or corporate bonds.
Sovereign bonds are, technically, risk-free because they are based on the currency of the issuing government. The government can always issue more currency to pay the bond on maturity. However, the bond may lose value and yields may drop. Some factors that affect the yield of a specific sovereign bond include the stability of the issuing government, the creditworthiness of the issuing government, and the value of the issuing currency on the currency exchange market.
Factors affecting the yield:
Creditworthiness: Credit rating agencies rate the issuing countries’ perceived ability to repay the debts.
Risk: Factors such as war and public disorder play a key role in deciding a country's ability to pay off the debts.
Exchange rates: If the bonds are issued in foreign currencies, there can be fluctuations in the exchange rate, leading ways to an increased pay-out pressure on the issuing government.