Introduction
A sovereign bond, also known as a government bond, is a debt security issued by a national government. These bonds can be availed in either domestic currency or foreign currency, and they serve as a way for governments to raise funds for various purposes, such as infrastructure development, social programs, or, historically, financing wars. The yield on sovereign bonds is the interest rate the government pays to bondholders, representing the cost at which a national government can borrow money.
Sovereign bonds, like other types of bonds, offer a fixed interest rate over a set period, with the principal amount repaid upon maturity. These bonds are often rated by credit agencies, which assess the risk of investing in the bond based on the government's financial health and ability to meet its obligations. Governments issue these bonds to meet fiscal needs, essentially borrowing from the market to fund expenditures.
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 analyze 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 to an increased pay-out pressure on the issuing government.
